Hedge fund industry looks to court regulators, critics, media

KEY BISCAYNE, Fla. — The $1.2 trillion hedge fund industry, bracing for its second regulatory battle with the Securities and Exchange Commission in as many years, plans to take a more proactive approach to dealing with regulators, critics and the media.
“The goal is to get out ahead of regulatory issues and help the regulators understand what it is we do,” said Robert Aaron, chairman of the Managed Funds Association, a Washington-based trade group that represents hedge funds.
At the MFA’s annual networking conference here last week, the other- wise casual gathering of more than 500 industry representatives was somewhat overshadowed by the SEC’s latest attempt to ratchet up its regulatory oversight of hedge funds.
After failing in its efforts last year to require hedge fund managers to register as investment advisers, the SEC in December proposed an increase in the suitability standards for hedge fund investors by increasing the liquid-net-worth requirements.
The MFA, while not expected to roll over and accept the proposed rule changes, is trying to adjust to the new reality that the days of operating in relative obscurity are over.
“Fifteen years ago [when the MFA was established], we didn’t get much press coverage, and we didn’t seek much press coverage, but one of our major endeavors now is to get the hedge fund story out there for more fair and balanced coverage,” said John Gaine, the association’s president. “I think there are real, versus perceived, issues with regard to hedge funds.”
Drafting a response
The MFA board will meet next month to draft a response to the SEC’s proposed changes to the investor suitability standards.
The public-comment period runs through March 9.
Mr. Aaron declined to discuss the likely tone of the MFA’s comment letter to the SEC but said that the association is considering the effect the proposed changes could have on smaller hedge funds still trying to build a track record and attract investors.
“It really raises the investor standards, and I would think it will hurt the smaller hedge funds,” he said.
In addition to the revised investor suitability standards, the SEC’s proposal would introduce anti-fraud rules aimed specifically at hedge fund managers, which is something the industry will have a difficult time challenging.
“It’s going to be hard for the industry to stand up and say it is for fraud,” said Barry Barbash, a partner at New York-based law firm Willkie Farr & Gallagher LLP and a former director of the SEC’s division of investment management.
“The [SEC] commission staff is trolling, and they’re worried, and they’re not sure why,” he added. “They already tried to directly regulate hedge fund managers under the Investment Advisers Act, and effectively, the SEC is now saying if they can’t regulate directly, they’ll regulate through enforcement, and that is the worst kind of regulation.”
A few points that the MFA is likely to underscore in its comment letter are the risks associated with overregulating a diverse industry of more than 10,000 hedge funds.
The MFA has long promoted the notion that the hedge fund industry is indirectly regulated through relationships with various regulated counterparties such as prime brokers.
The industry is also keen on pointing out that of the 2,500 hedge fund managers that registered before the registration rule was overturned in June, 2,200 are still registered with the SEC.
By the MFA’s calculations, half of the 100 largest hedge fund managers are registered with the SEC, and those 100 hedge funds account for about 60% of all hedge fund assets.
The so-called institutionalization of hedge funds, in which firms become larger and more sophisticated, is also “pushing the hedge fund industry toward better practices and better analysis,” according to Paul Roth, founding partner at New York-based law firm Schulte Roth & Zabel LLP.
In addition, more pressure to regulate hedge funds is coming from the new Congress, he said.
John Breaux, a former Democratic senator from Louisiana who is now senior counsel at Washington-based law firm Patton Boggs LLP, warned in his keynote speech of the risks of leaving lawmakers in the dark.
“You people carry a lot of clout, and [the lawmakers] want to know you,” he said.