SEC May Boost Its Role in Hedge Funds

The Securities and Exchange Commission staff is set to recommend that hedge funds be required to register with the agency, according to people familiar with the staff’s report on the $600-billion hedge fund industry.

Under the proposal, the SEC would for the first time get the authority to audit these largely unregulated investment pools for the wealthy. SEC Chairman William H. Donaldson has said the funds control too much money to be exempt from agency oversight.

Requiring registration would open hedge funds to routine SEC inspections. Currently, the SEC’s responsibility is largely limited to investigations of fraud at the funds.

The SEC staff recommendation, which follows a 15-month fact-finding investigation, may be released as early as Monday, the people familiar with the report said. They said the report, a draft of which has been circulated to senior SEC staff and commissioners, may still be changed.

“We would be very pleased to see any move by the commission to require registration and some level of transparency,” said Damon Silvers, associate general counsel at the AFL-CIO, whose union members’ benefit plans represent $5 trillion in assets.

“Not only are hedge funds unregulated, they are unobserved. And our markets really live on transparency,” Silvers said.

SEC spokesman Herb Perone declined to comment on the report.

The number of hedge funds has more than doubled in the last five years, according to consulting firm Tremont Advisors. Today’s 6,000 funds, up from about 2,500 five years ago, have about $600 billion under management, compared with about $50 billion in 1990.

This month, New York Atty. Gen. Eliot Spitzer accused hedge fund Canary Capital Partners of engaging in illegal or improper trading in mutual fund shares. Canary and its managing principal, Edward Stern, agreed to pay $40 million to settle Spitzer’s charges.

The idea of greater SEC oversight of hedge funds is opposed by some industry representatives and at least two Republicans on the five-member SEC, Paul Atkins and Cynthia Glassman. Atkins and Glassman have previously indicated that they were unconvinced the SEC should regulate hedge funds.

Donaldson, a Republican, has voiced concern about hedge fund fraud since he took the SEC’s helm in February. In 2002, the agency charged 12 funds with fraudulent practices, the same number as in the three previous years combined.

“It’s hard to tell exactly what is going on inside some of these funds,” Donaldson said in May while testifying before a congressional subcommittee. “We need one way or another to know more about this phenomenon.”

Many hedge funds engage in speculative investing, often using borrowed money to bet on increases or declines in securities. Hedge funds are limited to investors who have at least $1 million in net worth. The SEC staff is unlikely to recommend changing the net worth limit, the people said.

The staff report will detail the agency’s investigation of the funds, which in recent years have attracted smaller investors and pension funds seeking higher returns. The staff has interviewed 67 hedge fund managers, representing more than 650 funds with about $162 billion in assets, the agency has said.