Hedge Funds Making Way For Government Regulation
<br>
Industry Faces New Realities, Investors Who Want Assurances
<br>
<br>
By Zachary A. Goldfarb and David Cho
<br>
Washington Post Staff Writers
<br>
Saturday, March 14, 2009; D02
<br>
<br>
<br>
<br>
The hedge fund industry, battered and humbled by the market downturn, is no longer planning to fight against an increased role for government in regulating and inspecting the secretive investment pools.
<br>
<br>
Opposition has melted away as the market decline and prominent frauds have shattered the confidence of the pension funds, university endowments, charities and wealthy individuals who invest in the exclusive investment pools.
<br>
<br>
The new openness to regulation reflects the desire of investors for a government stamp of approval before they invest their money, said Barry Greenberg, a lawyer at Akin Gump who advises hedge funds.
<br>
<br>
Congress, which this week kicked off a series of hearings on new financial regulations, is contemplating a variety of rules to govern hedge funds. The industry has shown a willingness to consider a number of new initiatives, including a registration requirement, which would subject funds to periodic examination, and the creation of a regulator with the authority to ask them questions about their investments and business practices. The industry is split over how much funds should disclose to regulators about investments. And it opposes efforts to limit what they can invest in and how much they can borrow.
<br>
<br>
"There is concern about the utility of providing tons and tons of detail about individual portfolio positions," said Andrew Baker, chief executive of the Alternative Investment Management Association.
<br>
<br>
The new attitude by hedge funds reflects the new reality facing the industry. As many as 2,000 of 10,000 hedge funds closed last year as clients redeemed their investments, according to various industry estimates. And the total amount of assets invested in hedge funds worldwide was cut nearly in half to $1.9 trillion.
<br>
<br>
As a result, the long-established compensation structure of funds, in which they are paid 2 percent of assets and 20 percent of profits, is being reeval‎uated by fund managers. In some cases, funds are receiving 1 percent of assets and 15 percent of profits.
<br>
<br>
Investors "are now more skeptical about what they're paying for, and that's causing them to revisit fees with the funds they're invested," said Adam Zoia of Glocap, a firm that advises on hedge fund compensation.
<br>
<br>
A series of recent frauds has also given rise to changes in the industry.
<br>
<br>
Late last month, the Securities and Exchange Commission identified what appears to be the largest hedge fund fraud ever, a scheme in New York that is accused of stealing up to $563 million from investors. Using that money, the hedge fund managers bought homes, horses and even an $80,000 teddy bear, the SEC alleged. Investors included Carnegie Mellon University, the Iowa Public Employees Retirement System and others.
<br>
<br>
Joel Schwab, a managing director at HedgeFund.net, a data source on the industry, said investors are pressuring funds to hire independent administrators, brokers and auditors that will ensure everything adds up. Schwab said that even though he wasn't running a hedge fund, the Bernard L. Madoff case has heightened concern among many investors.
<br>
<br>
The SEC has tried to regulate hedge funds before. In 2004 it enacted rules requiring every hedge fund to register with the SEC, but those rules were struck down in federal court. Nevertheless, about a fifth of all fund firms have since registered with the agency. Some at the SEC are pushing for new rules to bring more scrutiny to the hedge fund market.
<br>
<br>
"We're totally unable to discern what's going in this particular market," SEC Commissioner Luis A. Aguilar said. "You have no idea how many dollars are involved, you have no idea what type of risk-taking is happening, you don't know if they're investing in vanilla securities or investing in the riskiest instruments."
<br>
<br>
As Congress considers regulating hedge funds, two issues are front and center. The first is that hedge funds could grow so big that they could endanger the entire financial system: so called systemic risk. A second is that hedge funds, as unregulated entities, are ripe for fraud, either ripping off investors or manipulating the market.
<br>
<br>
The Federal Reserve has been discussed by lawmakers as the likely candidate to become the regulator of systemic risk. The SEC, and potentially a sister agency responsible for certain derivatives, the Commodity Futures Trading Commission, may have other responsibilities.
<br>
<!-- -->
