Hedge Fund Regulation Is Ordered

WASHINGTON â€”  A divided Securities and Exchange Commission voted Tuesday to impose new oversight on hedge funds, the fast-growing investments that have thrived in an unregulated marketplace.

The 3-2 vote capped a pointed debate in which Republican Chairman William H. Donaldson argued that the public would benefit from stronger federal regulation of the funds, some of which played key roles in trading abuses involving mutual funds.

Donaldson, backed by the SEC’s two Democratic commissioners, said regulators didn’t know enough about these funds. Hedge funds have traditionally catered to wealthy, sophisticated investors, but industry experts say employee pension systems are increasingly investing in them too -- giving middle-class workers a stake in how they are managed.

It “would be a major dereliction of the commission’s responsibility� not to monitor hedge funds, Donaldson said.

The funds, which are believed to hold $870 billion in assets, often employ aggressive and risky strategies, such as betting on whether a stock will lose value in the future, in hopes of big returns. Typically, the minimum investment is $1 million.

Federal Reserve Chairman Alan Greenspan, Treasury Secretary John W. Snow and some members of Congress have argued that oversight isn’t necessary for an industry catering to an elite clientele well aware of any risks.

Under the new SEC rule, hedge funds must register their names, addresses and other information with the agency, including detailing the value of their assets. Regulators will be able to review the funds’ books.

The new requirements, scheduled to take effect in February 2006, will apply to hedge funds with at least $25 million in assets and 15 U.S. clients.

Although the mandates have been fiercely resisted by the industry as a whole, some individual hedge funds voluntarily register with the SEC already.

The 3-2 vote Tuesday was the latest in a series of ideological rifts inside the SEC, in which Donaldson has sided with the two Democratic commissioners in favor of more activist government regulations that the two other Republicans have opposed.

Earlier this year, for example, those same battle lines led to a 3-2 vote to require independent board chairmen at mutual fund companies who are not affiliated with the funds’ managers. Donaldson also is struggling with a similar division over a proposal to give shareholders a greater voice in the nomination of corporate board members.

Opponents of greater hedge fund regulation complained Tuesday that the SEC had rushed the rule to passage, while failing to identify a specific problem that it was supposed to solve. The SEC staff began its review of hedge funds more than two years ago and proposed the new rule in July.

“I’m disappointed in the approach we chose and know that we can and must do better,� said Republican Commissioner Cynthia A. Glassman, who took the unusual step of releasing a statement of dissent. “I believe it is the wrong solution to an undefined problem.�

Her GOP colleague, Paul S. Atkins, contended that the SEC would be wiser to target its resources on such areas as mutual funds, which are marketed to the general public.

“I am befuddled as to why we are charging ahead in the face of such a groundswell of principled opposition to this action,� Atkins said.

Supporters of the rule pointed out that the SEC had brought 51 cases involving hedge fund fraud over the last five years, and that hedge funds played a prominent role in abusive trading among mutual funds, including prohibited late-trading strategies.

Hedge funds also have burgeoned in size, increasing fivefold in the last decade, and are predicted to surpass $1 trillion in assets as early as next year.

“Given the substantial and growing risks for millions of investors

Opponents weren’t convinced. Attorney Daniel Schloendorn of Willkie Farr & Gallagher in New York, who represents hedge funds, said in an interview that the SEC had underestimated the cost of complying -- SEC staff put it as low as $20,000 per hedge fund manager -- while exaggerating the benefits of new regulation.

The Managed Funds Assn., which represents 800 hedge funds, expressed disappointment in the SEC vote but vowed to work with regulators to comply with the new requirements.

“It remains our opinion, and one that is obviously widely held, that the case for the SEC’s proposal was not made,� association President John G. Gaine said.