A Loophole for Hedge Funds

Next year, hedge funds have to register with the SEC. Funds will also have to provide more information, plus they’re subjected to periodic audits. However, there’s one loophole that many funds are using.

But the SEC’s rule only applies to advisors that permit investors to redeem their interests in a hedge fund within two years of purchasing their stakes. The agency concluded that the average “lockup” period for hedge funds is 12 months, so the 12-month period is the time frame covered by the rule.
“We’re aware that some hedge-fund advisers are planning to extend their lockup period and we’ll evaluate the situation when we have a better picture of the situation in February,” said Robert Plaze, associate director of the SEC’s investment-management division. However, the SEC’s registration rule proved quite contentious, even within the agency, so in the near term it may be difficult for the SEC to adjust the rules to capture the lockup extenders.
Some of the largest firms, like SAC, with $6.5 billion under management, and Kingdon, are in the process of instituting longer-term lockups. Others, such as Lone Pine, which manages $6.9 billion, aren’t open to new investors and don’t need to register. Citadel, a $12 billion firm, and Eton Park, which manages $3 billion, have always featured long-term lockups for the bulk of their money, so the SEC’s rules don’t apply.

It’s difficult to regulate an industry that was created specifically to avoid regulation. The hedge funds will play every angle.

“We have seen a rise in the number of firms asking for two-year lockups and the driver of that is probably the SEC requirements,” says Thomas Schneeweis, director of the Center for International Securities and Derivatives Markets at the University of Massachusetts. “If you can pull it off, let’s face it, you’d do it.”
So far, the anticipated flood of new registered investment advisers has yet to materialize. An estimated 5,000 or so of the approximately 8,000 existing hedge funds aren’t yet registered. So far this year, however, new registrations average about 100 a month, according to SEC data, not much more than last year’s 80-a-month pace.

Posted by on November 10th, 2005 at 3:31 pm


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