Skip to main content

Updated from 12:56 p.m. EDT

A new era of hedge fund regulation is one step closer to reality.

In a widely expected move, a divided

Securities and Exchange Commission

approved a plan to require most hedge fund managers to register with the agency. The plan would give the SEC the power to periodically review the books of hedge funds, which now control some $850 billion in assets.

The plan, which has been under consideration for more than a year, had been hotly opposed by the hedge fund industry. Many fear the registration requirement is the first step in an inevitable path to tighter regulation of hedge funds.

But supporters of the plan, including SEC Chairman William Donaldson, say registration is necessary to help regulators spot fraudulent trading activity among the investment pools, which cater to the rich.

Donaldson, a Republican, sided with the SEC's two Democratic commissioners, Roel Campos and Harvey Goldschmid, in approving the registration requirement. Two Republican commissioners, Paul Atkins and Cynthia Glassman, voted against the proposal.

"In moments of candor, lawyers for hedge fund advisers have admitted that their clients often push the line as to what is legally permissible, and their clients don't want to be second-guessed,'' said Paul Roye, SEC director of investment management, arguing in favor of the rule. "Unfortunately, the commission's enforcement docket demonstrates that many have crossed that line.''

The registration requirement, however, is not yet the law of the land. The SEC vote begins a 60-day public comment process, after which the proposal could be amended or scrapped, although the latter option is unlikely. A final version of the registration rule probably won't take effect until later this year.

For many big hedge funds, the registration requirement is no big deal. The SEC estimates that already between 40% and 50% of hedge fund advisers are registered with the SEC. Existing regulations require any hedge fund adviser that oversees 10 or more funds to register.

TheStreet Recommends

The proposed rule also wouldn't apply to very small hedge fund managers with less than $25 million in assets under management.

Still, opponents say the registration requirement is unnecessary because it will increase costs for many hedge funds and divert attention at the SEC away from other problems.

"I think it's a bad idea,'' says Harry Davis, a lawyer with Schulte Roth & Zabel, which represents many large hedge funds. "It runs the risk of stretching the SEC too thin.''

Critics also point out that even without the new regulation, the SEC has the authority to investigate allegations of fraud or misconduct at a hedge fund.

But usually by the time the SEC gets involved in a fraud investigation, a hedge fund is well on its way to collapsing and investors have lost much of their money. Regulators hope periodic examinations will serve as an early warning system, an alert them to the possibility that a hedge fund manager may be inflating asset values in order to boost a fund's performance and the manager's fees.

In recent years, some of the most spectacular hedge fund debacles have stemmed from managers deliberately overstating asset values. Such allegations have led to the demise of Kenneth Lipper's

Lipper Funds

, Michael Lauer's

Lancer Management Group

and New Jersey fund

Beacon Hill Asset Management