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Hedging Your Bets:
A Heads Up on Hedge Funds and Funds of Hedge Funds What are hedge funds? Like mutual funds, hedge funds pool investors' money and invest those funds in financial instruments in an effort to make a positive return. Many hedge funds seek to profit in all kinds of markets by pursuing leveraging and other speculative investment practices that may increase the risk of investment loss. Unlike mutual funds, however, hedge funds are not required to register with the SEC. Hedge funds typically issue securities in “private offerings” that are not registered with the SEC under the Securities Act of 1933. In addition, hedge funds are not required to make periodic reports under the Securities Exchange Act of 1934. But hedge funds are subject to the same prohibitions against fraud as are other market participants, and their managers have the same fiduciary duties as other investment advisers. What are "funds of hedge funds?" A fund of hedge funds is an investment company that invests in hedge funds -- rather than investing in individual securities. Some funds of hedge funds register their securities with the SEC. These funds of hedge funds must provide investors with a prospectus and must file certain reports quarterly with the SEC. Note: Not all funds of hedge funds register with the SEC. Many registered funds of hedge funds have much lower investment minimums (e.g., $25,000) than individual hedge funds. Thus, some investors that would be unable to invest in a hedge fund directly may be able to purchase shares of registered funds of hedge funds. 
What information should I seek if I am considering investing in a hedge fund or a fund of hedge funds? - Read a fund's prospectus or offering memorandum and related materials. Make sure you understand the level of risk involved in the fund's investment strategies and ensure that they are suitable to your personal investing goals, time horizons, and risk tolerance. As with any investment, the higher the potential returns, the higher the risks you must assume.
- Understand how a fund's assets are valued. Funds of hedge funds and hedge funds may invest in highly illiquid securities that may be difficult to value. Moreover, many hedge funds give themselves significant discretion in valuing securities. You should understand a fund's valuation process and know the extent to which a fund's securities are valued by independent sources.
- Ask questions about fees. Fees impact your return on investment. Hedge funds typically charge an asset management fee of 1-2% of assets, plus a "performance fee" of 20% of a hedge fund's profits. A performance fee could motivate a hedge fund manager to take greater risks in the hope of generating a larger return. Funds of hedge funds typically charge a fee for managing your assets, and some may also include a performance fee based on profits. These fees are charged in addition to any fees paid to the underlying hedge funds.
Tip: If you invest in hedge funds through a fund of hedge funds, you will pay two layers of fees: the fees of the fund of hedge funds and the fees charged by the underlying hedge funds. - Understand any limitations on your right to redeem your shares. Hedge funds typically limit opportunities to redeem, or cash in, your shares (e.g., to four times a year), and often impose a "lock-up" period of one year or more, during which you cannot cash in your shares.
- Research the backgrounds of hedge fund managers. Know with whom you are investing. Make sure hedge fund managers are qualified to manage your money, and find out whether they have a disciplinary history within the securities industry. You can get this information (and more) by reviewing the adviser’s Form ADV. You can search for and view a firm’s Form ADV using the SEC’s Investment Adviser Public Disclosure (IAPD) website. You also can get copies of Form ADV for individual advisers and firms from the investment adviser, the SEC’s Public Reference Room, or (for advisers with less than $25 million in assets under management) the state securities regulator where the adviser's principal place of business is located. If you don’t find the investment adviser firm in the SEC’s IAPD database, be sure to call your state securities regulator or search the NASD's BrokerCheck database for any information they may have.
- Don't be afraid to ask questions. You are entrusting your money to someone else. You should know where your money is going, who is managing it, how it is being invested, how you can get it back, what protections are placed on your investment and what your rights are as an investor. In addition, you may wish to read NASD’s investor alert, which describes some of the high costs and risks of investing in funds of hedge funds.
What protections do I have if I purchase a hedge fund? Hedge fund investors do not receive all of the federal and state law protections that commonly apply to most registered investments. For example, you won't get the same level of disclosures from a hedge fund that you'll get from registered investments. Without the disclosures that the securities laws require for most registered investments, it can be quite difficult to verify representations you may receive from a hedge fund. You should also be aware that, while the SEC may conduct examinations of any hedge fund manager that is registered as an investment adviser under the Investment Advisers Act, the SEC and other securities regulators generally have limited ability to check routinely on hedge fund activities. The SEC can take action against a hedge fund that defrauds investors, and we have brought a number of fraud cases involving hedge funds. Commonly in these cases, hedge fund advisers misrepresented their experience and the fund's track record. Other cases were classic "Ponzi schemes," where early investors were paid off to make the scheme look legitimate. In some of the cases we have brought, the hedge funds sent phony account statements to investors to camouflage the fact that their money had been stolen. That's why it is extremely important to thoroughly check out every aspect of any hedge fund you might consider as an investment. If you'd like to see an example of hedge fund fraud, click here. What should I do if I have a complaint about a hedge fund or a fund of hedge funds? If you encounter a problem with your hedge fund or fund of hedge funds, you can send us your complaint using our online complaint form at www.sec.gov/complaint.shtml. You can also reach us by regular mail at: Securities and Exchange Commission
Office of Investor Education and Advocacy
100 F Street, NE
Washington, D.C. 20549-0213 |
SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 275 and 279
[Release No. IA-2333; File No. S7-30-04]
RIN 3235-AJ25
Registration Under the Advisers Act of Certain Hedge Fund Advisers
AGENCY: Securities and Exchange Commission (the “Commission” or “SEC”).
ACTION: Final rule.
SUMMARY: The Commission is adopting a new rule and rule amendments under the Investment Advisers Act of 1940. The new rule and amendments require advisers to certain private investment pools (“hedge funds”) to register with the Commission under the Advisers Act. The rule and rule amendments are designed to provide the protections afforded by the Advisers Act to investors in hedge funds, and to enhance the Commission’s ability to protect our nation’s securities markets.
SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 275 and 279
[Release No. IA-2333; File No. S7-30-04]
RIN 3235-AJ25
Registration Under the Advisers Act of Certain Hedge Fund Advisers
AGENCY: Securities and Exchange Commission (the “Commission” or “SEC”).
ACTION: Final rule.
SUMMARY: The Commission is adopting a new rule and rule amendments under the Investment Advisers Act of 1940. The new rule and amendments require advisers to certain private investment pools (“hedge funds”) to register with the Commission under the Advisers Act. The rule and rule amendments are designed to provide the protections afforded by the Advisers Act to investors in hedge funds, and to enhance the Commission’s ability to protect our nation’s securities markets.
DATES: Effective Dates: February 10, 2005, except for the amendments to §275.206(4)-2 [rule 206(4)-2] and §279.1 [Form ADV], which will become effective January 10, 2005.
Compliance Dates: Advisers that will be required to register under the new rule and rule amendments must do so by February 1, 2006. Advisers must respond to the amended items of Form ADV in their next ADV filing after March 8, 2005. Section III of this Release contains more information on the effective and compliance dates.
FOR FURTHER INFORMATION CONTACT: Vivien Liu, Senior Counsel, Jamey Basham, Branch Chief, or Jennifer L. Sawin, Assistant Director, at 202-942-0719 or
This e-mail address is being protected from spam bots, you need JavaScript enabled to view it
, Office of Investment Adviser Regulation, Division of Investment Management, Securities and Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-0506.
Section by Section "Hedge Fund Disclosure Act" Introduced September 23, 1999 Representative Richard H. Baker (LA-06) - Section 1. The Act is titled as the "Hedge Fund Disclosure Act."
- Section 2. The Congress finds as follows:
(1) Hedge funds currently operate largely outside the framework of substantive United States banking, securities, and futures laws and regulations.
(2) The recent crisis of a large hedge fund demonstrated several ways in which the condition of major financial institutions in the United States, including many banks with federally insured deposits, reflects the success or failure of various hedge funds.
(3) Among other things, financial institutions often invest in hedge funds, lend to hedge funds, act as counter-parties in securities and derivatives transactions with hedge funds, and conduct proprietary trading activities that mirror the investment strategies of leading hedge funds.
(4) In several cases, hedge funds utilize financial leveraging practices to a greater degree than do many regulated financial institutions and this high degree of leverage exacerbates the extent to which such hedge funds potentially pose a threat to the safety and soundness of the United States and international financial systems.
(5) Given that most of the institutions and wealthy individuals that invest in hedge funds are highly sophisticated, market forces, rather than government regulations, are the best tools for constraining hedge funds from engaging in excessive leverage.
(6) Market forces are similarly the most effective means of disciplining financial institutions that have allowed hedge fund dealings to threaten their stability.
(7) The United States government must insure that the failure of one or more hedge funds never causes a severe burden on the U.S. financial system or the U.S. payments system and that federal resources are not squandered in efforts to salvage collapsed hedge funds.
(8) Market forces cannot properly function with respect to hedge fund risks without a minimum of reliable information about hedge funds activities.
The Act defines an unregulated hedge fund as any pooled investment vehicle that has capital of $3 billion or more and is privately organized, is administered by investment managers, is not widely available to the public, and is not registered under the Investment Company Act of 1940. Also, any group or family of pooled investments meeting the above criteria that has total assets under management of $20 billion or more is defined as an unregulated hedge fund for the purposes of this Act. - Section 4. Public Reporting Requirements
Within 15 days of the end of each quarter, an unregulated hedge fund must submit a report to the Federal Reserve Board that will include the following information:
- Section 5. Judicial Enforcement of Orders
To ensure compliance with reporting requirements, the Federal Reserve Board may seek enforcement of orders in the U.S. district court where the unregulated hedge fund is located. The Board may seek enforcement of orders in the U.S. district court for the District of Columbia for any unregulated hedge fund that is located in a foreign country that borrows, accepts investments from or is a counterparty to any person who resides within or is organized under U.S. law.
No court shall have jurisdiction to review, suspend, or modify an order or enforcement action issued pursuant to Section 4 of this Act.
Section 6. Public Disclosure of Direct Material Exposures to Significantly Leveraged Financial Institutions
Establishes the Sense of Congress that public companies, including financial institutions, should publicly disclose direct material exposures to significantly leveraged financial institutions including commercial banks, investment banks, finance companies, and hedge funds covered under this Act.
Directs the SEC, the CFTC, and the federal banking agencies to promulgate rules to require such disclosures.
Compliance Dates
The effective date of the amendments to rule 206(4)-2 and Form ADV is January 10, 2005. The effective date of new rule 203(b)(3)-2 and amendments to rules 203(b)(3)-1, 203A-3, 204-2, 205-3, and 222-2 is February 10, 2005. Hedge fund advisers may elect to begin complying with the new rule and the rule amendments as of their effective date, but have until February 1, 2006 to come into compliance with rule 203(b)(3)-2 and the amendments to rules 203(b)(3)-1, 203A-3, 204-2, 205-3, 206(4)-2, and 222-2. We are providing hedge fund advisers with this long transition period so that they have time to work through any technical issues as they prepare for registration. Our staff will be available to work with these new registrants on
By the compliance date, February 1, 2006, each adviser required to register under the new rule must have its registration effective, and must have in place all policies and procedures required under our rules. Each adviser must also have designated a chief compliance officer. Also by February 1, 2006, advisers must ensure that they are in compliance with our rule for custody of client funds and securities. We expect that most private funds are already subject to an annual audit and that advisers will elect to have the audit results distributed to investors within the appropriate time period under the custody rule. Some advisers, however, may need to either arrange for their private funds to be audited or for quarterly transaction statements to be distributed to the investors in lieu of audit results.
Minimum Assets Under Management Rule 203(b)(3)-2 does not alter the minimum amount of assets under management that an investment adviser generally must have in order to register with the Commission. A hedge fund adviser whose principal office and place of business is in the United States cannot (subject to certain exceptions) register with the Commission unless it manages at least $25 million. A hedge fund adviser whose principal office and place of business is outside the United States (an “offshore adviser”) must register with the Commission if it has more than fourteen clients who are resident in the United States regardless of the amount of assets the adviser has under management. We are not applying the $25 million threshold to offshore advisers, as urged by some commenters, because that threshold is premised on regulation of the unregistered adviser by one or more states in which the adviser has its principal office and place of business.
In determining the amount of assets it has under management, a hedge fund adviser whose principal office and place of business is in the United States must include the total value of securities portfolios in its assets under management. That is, it may not reduce the value of those assets by amounts borrowed to acquire them. An adviser may exclude proprietary assets invested in the fund, and need not include the value of assets attributable to non-U.S. investors.
D. Rule 203(b)(3)-2 For Investment Advisers
Rule 203(b)(3)-2 requires investment advisers to count each owner of a “private fund” towards the threshold of 14 clients for purposes of determining the availability of the private adviser exemption of section 203(b)(3) of the Act. As a result, an adviser to a “private fund,” which is defined in rule 203(b)(3)-1 and discussed below, can no longer rely on the private adviser exemption if the adviser, during the course of the preceding twelve months, has advised private funds that had more than fourteen investors. Furthermore, an adviser that advises individual clients directly must count those clients together with the investors in any private fund it advises in determining its total number of clients for purposes of section 203(b)(3). If the total number of individual clients and investors in private funds exceeds fourteen, the adviser is not eligible for the private adviser exemption and must register with us, assuming it meets our minimum requirements for assets under management.
The new rule is designed to amend the method of counting that hedge fund advisers use for purposes of applying the private adviser exemption. It is not intended to alter the duties or obligations owed by an investment adviser to its clients. xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx SEC and SEBI Announce Increased Cooperation of Capacity Building Events in India FOR IMMEDIATE RELEASE
2008-3 Washington, D.C., Jan. 8, 2008 - The Securities and Exchange Commission and the Securities and Exchange Board of India (SEBI) today announced terms for increased cooperation and collaboration. SEC Chairman Christopher Cox and SEBI Chairman M. Damodaran elaborated the terms establishing the structure of, and agenda for, an SEC-SEBI dialogue. This new dialogue has three main objectives: - Identify and discuss regulatory issues of common concern
- Continue and expand upon the existing program of capacity-building and technical cooperation between the SEC and the SEBI
- Improve cooperation and the exchange of information in cross-border securities enforcement matters
"As financial services and investment continue to grow and expand between the United States and India, the SEC and SEBI are increasingly working together to facilitate our aims of investor protection and healthy markets," said Chairman Cox. "The SEC has worked with SEBI over the past few years on extensive capacity-building programs as well as enforcement matters. I look forward to continuing and strengthening our regulatory and enforcement cooperation with SEBI through this high-level dialogue." Chairman Damodaran said, "Given the role that emerging and recently emerged markets play in an increasingly globalised financial world, it is only befitting that the SEBI and SEC work closely for the protection of investors and for ensuring fair, efficient and transparent markets. The high level discussions between the two regulators, while promoting capacity building, would also enable both the SEBI and SEC to take suitable joint and collective action where needed." Ethiopis Tafara, Director of the SEC Office of International Affairs, said, "This framework for discussion will benefit and shape the SEC staff's continued interaction with officials from the SEBI. The SEC staff has engaged in over two dozen projects related to the Indian markets and met with over 1,000 Indian officials. The new dialogue will build upon these efforts and provide the SEC and SEBI with further opportunities to enhance securities regulation." The dialogue will be composed of regular meetings and ad hoc information exchange at the staff level and between high-level representatives of the SEC and SEBI. Given recent developments in both the U.S. and Indian markets, the following topics have been identified for discussion for the dialogue over the coming year: - Oversight of dually regulated entities
- Regulatory and compliance issues relating to outsourcing
- Accounting and auditing standards
- Corporate governance standards and internal controls
- Areas for continued capacity-building and technical cooperation
- Cross-border cooperation and information sharing in securities enforcement matters
The SEC and SEBI agree that this is not an exclusive list of issues to be discussed in the dialogue and that the list may be revised as new regulatory issues affecting the India and U.S. markets emerge in the course of the year. The SEC-SEBI dialogue was announced after completion of an extensive two-week, SEC-SEBI capacity-building and technical cooperation session on a variety of topics held in India at the end of December 2007. Highlights of the capacity-building effort were two training programs and a CCOutreach program for chief compliance officers of U.S. registered investment advisers located in Asia. In the CCOutreach program, topics included compliance risk assessment, establishing and testing compliance controls and common deficiencies found in SEC examinations. The capacity-building programs conducted by the SEC involved a four-day training program in Mumbai on Securities Market Oversight and Enforcement which 55 Indian regulators attended. Topics included broker-dealer compliance, hedge fund regulatory concerns, broker-dealer and investment adviser inspections, insider trading, and market manipulation. The SEC also conducted a two-day training program in New Delhi on corporate finance and corporate disclosure which 25 officials for SEBI regional offices attended. Topics included the offering process, financial fraud, asset-backed securities and corporate governance. http://www.sec.gov/news/press/2008/2008-3.htm
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