The SEC is planning to launch an investigation of possible fraud in the $500 billion hedge-fund industry, Chairman Harvey Pitt said today in a speech to the Investment Company Institute.
The move comes in the aftermath of several enforcement cases involving hedge funds, according to the SEC.
Pitt has been under pressure recently for seemingly slow to investigate Wall Street's research analysts. Indeed, many say that he has been totally embarrassed by Eliot Spizter, the New York State attorney general who led the investigation against Merrill Lynch. And he has been criticized as being to have conflict-of-interest issues with accounting firms, for whom he once represented in private practice.
Currently, hedge funds are not subject to reporting requirements because they're private funds, unlike mutual funds, which are subject to reporting. As a result, Pitt claims information about hedge funds "is sketchy."
According to an SEC spokesperson, the investigation is indirectly tied to the New York State Attorney General's probe into Wall Street firms' research and investment banking relationships that resulted in Merrill Lynch being fined $100 million this week. The SEC's concern, it says, is public trust and industry integrity.
The SEC "is concerned" about the implications flowing from the growth in private investment funds. Hedge funds had record net inflows of $31 billion last year, increasing assets to $500 billion.
Hedge funds are private investment partnerships and are limited to sophisticated, wealthy investors--those with $200,000 a year in income or $1 million in net worth. First launched decades ago, the hedge fund was just that: a hedging vehicle to try to make money in any kind of market. Over the last decade or so, hedge funds, because of their status as non-registered investment partnerships, morphed into more aggressive, highly leveraged vehicles, employing speculative strategies.
Hedge funds have been growing in popularity; some are even registering with the SEC so that they may market the funds to accredited investors. Today, the unregistered fund may not advertise. Mutual fund companies and other financial firms have been expanding their hedge fund business to attract more investors.
The SEC worries that the absence of regulation may allow unscrupulous people to defraud investors, according to the SEC. The investigation could result into more stringent rule control over the unregulated funds, according to several brokers.
Brokers say they are somewhat surprised the SEC is launching an investigation into hedge funds, but that they're not surprised the rules governing the funds might be altered.
"This has been a popular subject, especially since 9/11 and the creation of the Patriot Act," says a Merrill Lynch rep. With threats of terrorism, the SEC wants to know everything it possible can about investment funds and accounts, according to the rep.
If the rules surrounding hedge funds change, "The cost of the funds will increase because they'll have to be more backup support and backup systems," says a UBS PaineWebber producer. "That will affect us [brokers] to some degree, but this isn't such a bad thing, other than the cost of the funds potentially rising."
The SEC's hedge fund probe will look at possible conflicts of interest associated with managing the fund, as well as how the funds are marketed to individual investors, Pitt said.
"What this may do is slow a segment of the industry that is rapidly escalating," the PaineWebber rep says.