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In a split vote, the Securities and Exchange Commission on Wednesday approved a proposal to require hedge fund managers to register with the agency and open their books to periodic government review. “For many years, this agency has taken a ‘sit back and watch’ approach to the hedge fund industry,” said SEC Chairman William Donaldson. “This proposal will allow the agency to move in a pragmatic way if we see hedge fund problems emerging.” Donaldson and Commissioners Roel Campos and Harvey Goldschmid supported the proposed rule, and they have argued that tighter oversight of the hedge fund industry will deter fraud and protect investors. Commissioners Paul Atkins and Cynthia Glassman opposed the proposal. Donaldson said the growing use of hedge funds, once geared toward wealthy individuals, by public and private pension funds as investment vehicles puts smaller investors at risk. Without registration, the agency cannot identify who manages the funds, how many funds operate in the U.S. or how much money is under management, he said. By contrast, Glassman and Atkins said the proposal would not help securities officials stop fraud. They contend that hedge funds do not pose a serious risk to average investors because pension fund exposure to hedge funds remains low. Of the $6 trillion in retirement plan assets held in the U.S, only 1.5 percent is invested in hedge funds, Glassman said. Refuting claims that hedge fund fraud is on the rise, the two noted that the SEC has brought only 46 cases against the investment pools since 1999, representing a fraction of the roughly 6,000 hedge funds operating in the U.S. Atkins also noted that many of the scandals involving hedge funds involved money managers who already are registered with a state or federal regulator. Many big hedge fund advisers register with the SEC to win confidence among big institutional investors. Finally, regulating hedge funds would take scarce SEC resources from the agency’s oversight of mutual funds and other regulated entities while raising compliance costs for hedge funds, the dissenting commissioners said. “If effective inspection is not what we have in mind or what we can deliver, we will appear to be doing more than we are, and that will be a disservice to investors,” Glassman said. Paul Roye, who heads the SEC’s Division of Investment Management, defended the registration rule. The agency is concerned that hedge fund fraud is more widespread than indicated by the handful of cases undertaken by the SEC’s enforcement division, he said. Hedge funds are estimated to have roughly $850 billion in assets under management. Under the proposal, the SEC would regulate hedge funds with $25 million or more under management, while state securities regulators would oversee managers with less than that amount. The SEC also is developing a “risk assessment” system that would target high-risk portfolios to help staffers minimize the agency’s costs in policing the industry. The proposal also stipulates that investors must have $1.5 million in assets to invest in hedge funds that charge a performance fee. The current threshold for investors to join unregistered funds is $1 million in assets or $200,000 annual income. There were moments of tension among commissioners in announcing the SEC’s decision. Atkins noted in his remarks that adopting the proposal would set the agency down a “slippery slope” toward even stricter regulation of hedge funds. But Campos called this assertion a “classic scare tactic,” saying there is no evidence that the SEC plans an even shorter leash for the industry. “To put out an argument like that would be disingenuous,” Campos said. The split at the SEC over the registration rule underscores the fault lines dividing commissioners and agency staffers on many key issues. In another controversial proposal, for example, commissioners appear to be stalled on a plan to give some shareholders a conditional right to nominate director candidates in corporate elections. SEC Division of Corporation Finance chief Alan Beller, who introduced the shareholder proposal earlier this year, offered congratulations to Roye shortly after the hedge fund vote. Both division heads have struggled to get commissioners to adopt key proposals recommended by their staffs. The SEC will seek public comment on the registration rule for 60 days, though many observers expect the agency to take up to three months to review it before holding a final vote. Copyright �2004 TDD, LLC. All rights reserved.

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