• Financial Services: Hedging For Hedge Funds
  • January 16, 2004 | Author: Robert P. Bramnik
  • Law Firm: Duane Morris LLP - New York Office
  • The Staff of the Securities and Exchange Commission's (SEC's) recently issued report, "The Implications of the Growth of Hedge Funds," recommends new regulations across a broad range of areas, including required registration of fund advisers (by "looking through" fund clients for purposes of Advisers Act Section 203(b)) and standardized fund performance reporting. Close examination of the report, however, suggests gaps in the Staff's understanding of how hedge funds operate -- including how to define "hedge fund." In-house counsel must prepare for new and substantive regulations and reporting in an area where the Commission admits it has limited knowledge.

    To navigate these potentially shifting sands, counsel should, at minimum, take the following steps:

    1. Make certain that, in the context of the U.S. Patriot Act compliance, all "financial institutions" adhere to the Treasury Department rules. That may sound like common sense, but overcompensating or doing too little risks not only the attention of the Treasury Department but also may make hedge fund clients candidates for broader SEC scrutiny.

    2. Be on the lookout for inappropriate lending practices respecting fund clients -- untoward leverage and loose margin treatment. In the context of a "fund of funds," ensure that the fund's performance is reported in a reasonable and consistent manner.

    3. Ensure that client fund investors, including all underlying beneficial owners, truly meet the requirements of all claimed statutory exemptions, whether under Reg. D or '40 Act Sections 3(c)(1) or (7).

    In-house counsel may be tempted to downplay the SEC's report until the regulations are finalized. Giving in to this temptation could have serious consequences for counsel and their clients.