Stewart Eisenhart: Parting Shot

Just in time for my last column as deputy buy-side editor at Waters, the US Securities and Exchange Commission (SEC) has proposed new rules to implement provisions of the Dodd–Frank Wall Street Reform and Consumer Protection Act mandating tighter regulation of hedge funds.

Concurrently, the Federal Bureau of Investigation raided the offices of large-tier hedge fund managers Diamondback Capital Management, Loch Capital Management and Level Global Investors on November 22 as part of an insider trading investigation. SAC Capital as well as mutual fund managers Janus Capital, Wellington Management and MFS are now under investigation, as well. Somebody in the government knows how to roll out a new regulatory initiative, if nothing else. Opponents of tighter investment and hedge fund management regulation will—and should—find it difficult to make their case in light of these events.

The SEC proposal more or less covers what industry participants have been expecting, such as mandatory registration under the Investment Advisers Act for funds managing more than $100 million. But the SEC has also proposed amendments to the Dodd–Frank Act that go beyond that original mandate. Managers may also be required to disclose information regarding the funds they manage, as well as counterparties and service providers such as prime brokers, administrators and custodians.

The SEC also seeks to require details from hedge fund managers about their clients, employees and advisory activities, as well as any business practices posing potential conflicts of interest such as affiliated brokers, soft-dollar arrangement and client referral compensation.

Even those managers exempt from SEC registration—those advising only venture capital funds or those with less than $150 million under management in the US—would have to meet new disclosure rules according to the SEC proposal. These managers would have to report identifying information about their owners and affiliates, details about the funds they manage as well as any business activities that may cause conflicts of interest, and disciplinary histories—indeed—of their employees.

But given the SEC’s challenges in terms of mustering adequate resources to enforce its mandates, how can it assume such expanded authority over the hedge fund industry without enough manpower? To address that, it seems the SEC will rely on state regulators under what it calls its “reallocation of regulatory responsibility.” Namely, hedge funds managing between $25 million and $100 million will fall under the regulatory supervision of the individual states in which they are based.

In a peculiar twist, the SEC’s proposal would require more than 4,000 of the 11,850 hedge funds currently registered under the Investment Advisers Act to switch their registration from the SEC to their respective state regulators. Hopefully that will not entail any major new compliance efforts after these managers spent considerable time and effort getting their ducks in a row to meet SEC requirements. No doubt states with little prior experience in hedge fund regulation will look to the SEC for guidance rather than reinvent the proverbial wheel.

Although not set in stone, hedge funds should now have a clear idea of what financial regulatory reform will mean for them, and where they should focus their technology and operational efforts in order to comply. It has, frankly, been a long time coming—perhaps if the US government had gotten its act together sooner, hedge fund-related scandals such as the one just now blowing up could have been averted.

Wrapping Up
After nearly eight years at Waters magazine and its predecessors Buy-Side Technology, Hedge Fund & Investment Technology and Buy Side IT, I’ll be stepping down as deputy buy-side editor. I want to thank all the investment management, vendor and consultancy sources who have provided such expert commentary over the years and deepened my understanding of technology issues that matter most to the industry. I must especially thank my longtime editor Victor Anderson, whose feedback and guidance were crucial to my success as a journalist at Incisive Media.