State regulators could struggle to monitor hedge funds outside of SEC remit

LegalOperational RiskRegulation
15 Aug, 2012

Provincial state regulators could struggle to effectively monitor hedge funds which fall out of the remit of the Securities and Exchange Commission (SEC), it has been warned.

New York regulators: Not to be stifled with

Managers with more than $100 million in Assets under Management (AuM) had to register with the SEC last March while those firms running over $150 million must submit a Form PF to regulators either quarterly or annually depending on AuM, as mandated under Dodd Frank. However, hedge funds with less than $100 million come under state regulators’ remit while those under $25 million are not regulated at all.

“Some states could struggle to implement and enforce regulation, particularly when there are few money managers operating out of the region. Many of (such) states do not have the budget, systems and experienced personnel for monitoring asset managers, while others do not have aggressive registration and anti-fraud laws,” said Holland West, partner at international law firm Dechert in New York.

However, West added some state regulators were perfectly prepared. “Take New York State, for example - New York has strong regulatory and enforcement staff and broad authority and laws and they will take aggressive action as we have seen with many hedge funds, asset managers, and banks.”

Standard Chartered, the UK-based emerging markets bank, for example, has just paid $340 million to New York’s bank regulator to settle claims it hid details about $250 billion worth of transactions with Iran, which were potentially in breach of tough US sanctions.

There is also an argument that sub-$25 million managers, which might target unsophisticated investors, should be subject to more stringent regulation. Theoretically, it is these managers rather than institutional hedge funds, where the risk of fraud and non-compliance is highest.

“While there is no statistical data suggesting that the risk of fraud at smaller hedge funds is higher, the fact remains that such managers are unlikely to have the controls and compliance infrastructure that exist at registered managers and demanded by regulators and investors.  However, regulators cannot regulate everyone. Some firms are just too small for the Federal Government to devote resources to. Does that mean some people will fall through the cracks? Yes, that is always going to happen,” said West.

Perhaps the biggest debate is whether the SEC has the manpower to handle all of the data it will receive from hedge funds. Congressional Republicans have repeatedly threatened to slash regulators’ already limited budgets while a Republican victory in the White House would almost certainly lead to cuts.

Speaking in April 2012 to COO in Washington DC, the SEC said it would allocate resources on a risk-based basis, adding it would focus on submissions where there were inaccuracies and inconsistencies in the data. The SEC also said it had bolstered its technology and staff to handle the increased workload.

Dodd-FrankForm PFNew YorkregistrationSECStandard Charteredstate regulators