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The Spokesman-Review Newspaper
Spokane, Washington  Est. May 19, 1883

Hedge funds require oversight

Neal Lipschutz Dow Jones Newswires

NEW YORK – By voiding the rule requiring U.S. hedge-fund advisers to register with the Securities and Exchange Commission over the legal definition of “client,” a federal court Friday left the watchdog agency unable to minimally regulate a burgeoning force in domestic and global markets.

The hedge-fund industry is growing in leaps and bounds, pulling in assets from individuals and pension funds. Hedge fund handiwork makes daily imprints on trading in stocks, bonds, foreign exchange, oil and just about anything else you can imagine. Activist hedge funds challenge public company management on a regular basis. The New York Times wrote Friday that hedge funds account for 30 percent of the nation’s stock trading volume.

Since February, most hedge-fund advisers have been required to register with the SEC and stand ready for routine inspections. Now, the SEC can’t even legally require disclosure of the names and addresses of the funds’ advisers, typically their general partners.

“It would be almost impossible for me to conceive of an SEC” that didn’t take notice of the lightly regulated hedge-fund industry, former SEC Chairman William Donaldson said as he prepared to leave office in June 2005.

Donaldson’s arguments for the rule stand on even stronger ground now than when the debate raged in 2004. It was never about protecting the supposedly sophisticated and wealthy individuals or college endowments that look to hedge funds to increase returns above more traditional and highly regulated investment vehicles. It was about how little the SEC knows about entities that have an increasing potential to affect broader markets.

But now, the relatively gentle way the SEC decided to start accumulating facts has been tossed out by the U.S. Court of Appeals for the District of Columbia Circuit.

At issue is the SEC’s determination that, for the purposes of this rule, actual investors in hedge funds would be considered “clients” of the adviser. If any adviser has more than 15 clients, he had to register.

Hedge fund adviser registration and mutual fund board independence were two issues that divided the SEC. Both passed by 3-2 votes, as then-Chairman Donaldson joined two Democrats to top two Republican dissenters. Now both rules have been stopped by court decisions.

The dissenters’ public policy arguments had merit and, even if one disagreed, it would be easier to accept a reversal based on principle than this legalistic rejection.

“Fraud deterrence is a laudable goal, but so is avoiding regulatory overreach,” SEC Commissioner Paul Atkins said in 2004.

Donaldson looked at it another way. He said critics couldn’t expect a vigorous, ahead-of-the-curve SEC if the agency was kept from even being informed about an important and growing market influence.

Friday, SEC Chairman Christopher Cox asked the agency’s staff to “promptly evaluate the court’s decision.”