SEC seeks emergency rules for hedge funds

WASHINGTON — With fraud among hedge funds on the rise and ordinary investors getting hurt, the chairman of the Securities and Exchange Commission said Tuesday he will push for new emergency regulations of the high-risk investment pools.

SEC Chairman Christopher Cox disclosed the plan in testimony before the Senate Banking Committee. It comes several weeks after a federal appeals court overturned the agency’s new rules for oversight of hedge funds, which traditionally catered to the very wealthy but are increasingly luring ordinary investors.

Concern about hedge funds’ explosive growth and virtually unbridled operations had prompted the SEC regulations, which required most hedge fund managers to register with the agency, thereby opening the funds’ books to SEC examiners. The appeals court ruling on June 23 left hedge funds — with assets estimated to exceed $1 trillion — in a regulatory vacuum, experts and regulators have said.

“The potential for retail investors to be harmed by hedge-fund risk remains” a serious concern, Cox testified. “And the growth in hedge-fund fraud that we have seen accompany the growth in hedge funds implicates the very basic responsibility of the SEC to protect investors from fraud, unfair dealing and market manipulation.”

Cox said he will recommend that the SEC adopt an anti-fraud rule for hedge funds that would establish serious obligations to investors on the part of fund managers and would meet the legal objections of the appeals court.

In its decision last month, the U.S. Court of Appeals for the District of Columbia Circuit sent the SEC’s hedge-fund oversight program — which bitterly divided the five SEC commissioners when it was adopted in October 2004 — back to the agency to be reviewed.

A three-judge appeals court panel found that the SEC, in its new rules, had contorted the legal definition of who can be considered a client of a hedge fund. The agency had previously considered hedge funds themselves to be the fund’s clients, as opposed to actual investors. The new rules changed the definition of clients to the investors.

Cox said Tuesday that the new rule he is proposing would “look through” hedge funds to their investors and would hinge on the fact that the appeals court noted that certain federal anti-fraud regulations are not limited to fraud against clients.

In addition, Cox told the Senate panel, he will direct the SEC staff to take several immediate actions which, among other things, would encourage the hundreds of hedge fund managers who voluntarily registered with the agency to remain so. And he has asked the staff for a report on the possibility of revising rules in a way that would raise income requirements for individual investors in hedge funds.

“These are not investments for Mom and Pop,” Cox told the senators.