December 20, 2006

SEC Pulls New Regulatory Trick From Sleeve

-- By Pushpa Sathish, Staff Writer

In spite of the setback it faced in enforcing regulations on the hedge fund industry in June this year, the US Securities and Exchange Commission (SEC) is doggedly pursuing its quarry and trying to bring hedge fund managers within its control. Following a federal appeals court rejecting the SEC’s attempt to bring about more transparency in the operations of hedge funds, the regulatory agency is now hitting the industry where it hurts the most – in its financial pockets.

A new SEC regulation, if passed, will increase the lower asset and wealth limit for potential investors in hedge funds; right now, if you are worth $1 million (value of your home included) or earn $200,000 ($300,000 for a couple) in two consecutive years, you are eligible to enter the hallowed portals of hedge funds. According to the proposed changes, only those with $2.5 million investable assets will be allowed to invest in hedge funds. The planned regulation will effectively reduce the number of people investing their money in hedge funds; only 1.3 percent of Americans will pass the test as against the 8.47 percent eligible now.

The arguments against this regulation are flying in fast and furious from the fund industry; lawyers representing the smaller funds claim that the reduction in numbers will affect only their clients, leaving the bigger fish virtually untouched. Employees of hedge funds will find themselves among the most affected, unable to invest in the fund they manage and work for.

The rule has flaws. For one, venture capital funds are exempted because they provide capital to start-up companies, raising the question of how a start-up company differs from a start-up investment manager.

Opposition to the proposed rule is pouring in, raising questions regarding its effectiveness in being used as a regulatory mechanism. If the larger funds do not have to change their MOs in any way after the regulation is passed, how successful is this rule going to be in getting the hedge fund industry to toe the SEC’s line? Let’s wait and watch!

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