Tighter rein on hedge funds slated

Donaldson, 2 Democrats join on regulation plan

July 15, 2004|By Robert Manor | Robert Manor,CHICAGO TRIBUNE

The Securities and Exchange Commission moved yesterday to increase its oversight of hedge funds, the sometimes volatile investment tools of the wealthy that now operate almost without regulation.

SEC Chairman William H. Donaldson, a Republican, joined two Democratic commissioners in voting to issue a proposal requiring hedge funds to register with the agency and disclose basic information about their management. Until recently, Donaldson had been in the Republican camp and opposed to increasing regulation.

"The commission's traditional approach to hedge funds has been to sit back and see what happens," Donaldson said. "I believe this course is no longer responsible."

The proposal now goes through a 60-day public comment period before coming up for a final vote.

Hedge funds are capital pools put together by investment advisers that cater to the wealthy, though in recent years some have reduced the minimum investment required to broaden their pool of investors. They are free to use risky strategies that are prohibited for garden variety mutual funds, such as trading in options, futures and other derivatives.

Hedge funds gained notoriety this year when it was disclosed that a New York fund, Canary Capital Partners LLC, had agreements to buy mutual fund shares at advantageous terms and prices not available to ordinary investors.

Some of the nation biggest financial houses - Bank of America, Janus Capital Group and Bank One - have paid a total of $2.3 billion in penalties since their participation in the scheme came to light.

The proposal yesterday would require all but the smallest hedge funds to register with the SEC as investment advisers, disclosing information such as their identity and the amount of money they manage. The SEC would gain greater ability to inspect their operations, making it easier to detect fraud. The agency also would require hedge funds to employ compliance officers to ensure that they break no securities laws.

Many hedge funds have voluntarily registered with the SEC. This is typically done to attract pension funds or other institutions that otherwise will not invest with a hedge fund.

But the Managed Funds Association, a trade group that includes hedge funds, opposes mandatory registration.

"Any resort to governmental regulation has to be carefully considered to ensure that the benefits afforded outweigh the burdens created," said John Gaine, the association president. "The case for mandatory investment adviser registration of hedge fund managers has not been made."

The sheer size of hedge funds, estimated to manage as much as $1 trillion in assets, unnerves some in the financial industry. In 1990, hedge funds managed only an estimated $50 billion.

Nor was Canary the first hedge fund to run into trouble.

In 1998, the Federal Reserve pushed major banks into funding a bailout for Long-Term Capital Management, a huge hedge fund that had badly misjudged the direction of interest rates. The Fed feared that if it the fund collapsed, it would imperil international finance.

"Ever since Long-Term Capital Management nearly caused a worldwide financial meltdown, it's been clear that hedge funds can have a huge impact," said John Coffee, a professor at Columbia Law School.

He said more regulation is warranted because hedge funds, once the domain of the rich, are now being marketed to the upper middle class.

Hedge funds can accept money only from individuals with assets of $1 million or more, or who have an annual income of at least $200,000.

When the industry adopted that rule, it was presumed that people in those brackets would be sophisticated investors able to understand the risks they were taking on. But many more people now qualify to invest than in the past. And some hedge funds have reduced their minimum investment to increase their appeal to well-to-do, but not necessarily rich, clients.

Donaldson's break with his party is notable. Recently, he voted with the Democrats to require that mutual funds have independent chairmen.

The Chicago Tribune is a Tribune Publishing newspaper.

Baltimore Sun Articles
Please note the green-lined linked article text has been applied commercially without any involvement from our newsroom editors, reporters or any other editorial staff.