WASHINGTON (HedgeWorld.com)–Sixteen months after the Securities and Exchange Commission voted 3 to 2 to adopt new rules requiring most hedge fund managers to register as investment advisers, the two dissenters are still showing signs of frustration with the way things turned out.
Paul S. Atkins, speaking on Feb. 28 to a conference of investment professionals put on by the Investment Adviser Association and the weekly IA Week newsletter, said the SEC is discovering just how much work is involved in requiring thousands of additional fund managers to register. According to a transcript of the speech, he said that despite a shift by the SEC's Office of Compliance Inspections and Examinations from a regular five-year exam cycle to a risk-based monitoring approach, the influx of adviser registrations is stretching SEC resources, to the possible detriment of investors.
Additionally, Mr. Atkins told the conference, the registration mandate caused other, perhaps unintended consequences. Some hedge fund managers extended their lock-up periods to two years to take advantage of a loophole in the rules designed to exclude private equity managers, which typically have longer lock-ups than hedge funds, from having to register. This lock-up extension, which he said was entirely predictable, also is potentially detrimental to investors. Commissioner Cynthia Glassman the other "no" vote on the hedge fund rules, echoed those same sentiments a week earlier in a speech in London.
Still other hedge fund managers haven't registered at all, waiting instead for the resolution of a court challenge to the new rule before deciding whether to sign up. It's a potentially risky strategy, but risk is not always a deterrent in the hedge fund industry.
"It is not an understatement to say that mandatory hedge fund adviser registration vastly expands the workload of the SEC. . . ," Mr. Atkins said. "We are discovering it is no small task to refocus a portion of our examination staff so that they can effectively inspect hedge funds."
Part of the problem is the sheer complexity of some hedge funds. While hedge funds tend to share many attributes with traditional managers–conflict-of-interest issues, custody and recordkeeping, for example–hedge funds' holding structures tend to be more intricate, the funds tend to trade more often, they frequently use leverage and their securities can sometimes be hard to value, Mr. Atkins said.
The SEC also has recently discovered that its Form ADV doesn't capture all the information necessary for a risk-based assessment system to work as well as it should, Atkins told the group. Among the suggestions for addressing this particular issue is increasing the amount of information the SEC collects by requiring quarterly filings. Since there's no way to strictly identify "hedge funds" on the ADV form, such a program would likely apply to most registered investment advisers. "Would it not be ironic if the hedge fund rule increased the regulatory burden on non-hedge fund advisers, as well?" Mr. Atkins asked.
During his speech, Mr. Atkins laid out what may be his main beef with the new hedge fund rules in language that would have made anyone in the room who hadn't been paying attention sit up and take notice. Doubtless that among those who approve of the new rules, he said, are fund managers who believe the SEC will be distracted enough by the challenge of its new enforcement mandate that they might be able to get away with things they might not have before.
"Because of this complexity, and the resulting diversion of staff resources, the new registration requirement could greatly impair our ability to oversee other investment advisers, whose activities are of much greater consequence to the investing public, based on sheer numbers of investors alone," Mr. Atkins warned. "We have seen time and again over the years just how difficult it is for any examiner or auditor to ferret out fraud at large and small retail-oriented investment advisers using straightforward long strategies.
