Has Congress Dumped Unreasonable Hedge Fund Oversight Responsibility on the States?
Under the new Dodd-Frank financial reform law, hedge funds with $100 million or less under management will be overseen by state regulators. While state securities regulators have done a remarkable job of enforcement given their limited funds, is Congress asking too much of them? The answer may be a resounding “yes” since the budget cuts in many states have resulted in a lack the funds and staff to do the job, according to an August 19, 2010 Wall Street Journal article by Kara Scannell, “States Will Be Hedge-Fund Police.” If that is the case, a major piece of financial reform may turn out to be illusory. That is because a disproportionate amount of fraud tends to be committed by these thousands of mid-sized and smaller hedge funds that will now be policed by the states.
"Fraud is more likely to happen with small managers than big managers," Christopher Wells, head of the hedge-fund practice at the law firm Proskauer Rose LLP, was quoted as saying. "Regulators and investors should be concerned that some of the states don't have the capacity to monitor what smaller managers are doing."
The new Dodd-Frank financial law requires all hedge funds and other investment advisor firms to register with regulators and undergo exams. But only those with more than $100 million under management will be regulated by the Securities and Exchange Commission. The rest will be overseen by states. Under earlier laws, threshold was $25 million. The SEC estimates that state regulators will have to oversee approximately 4,000 more advisory firms than before.
"Right now, as it is, the states don't have the budget or the manpower to even deal with the advisers that they have," one lawyer who advises several smaller hedge funds was quoted as saying. "You're lucky if the states [examine firms] on a three-year basis. I've had certain clients who have never been audited."
As has been widely reported, state budgets are being cut, and some regulators have been furloughed. Some states are considering their options including boosting fees. California, for example, is "reviewing our rate structure" as a way to add staff.
Denise Crawford, the securities commissioner of Texas and head of the National Association of State Securities Administrators (NASAA), sounds more optimistic. "Over 3,000 investment advisers have never been examined by the SEC. That is frightening in this environment. It just makes good sense from an investor-confidence standpoint to divide up this world," she was quoted as saying.
Ms. Crawford reportedly expects the number of advisers her department oversees will double to 2,400, and the number of examiners will increase from 19 to 29. However, examiners only “try to” inspect every adviser once every five years, according to Ms. Crawford.
Is one inspection visit every five years by a single examiner likely to uncover financial fraud? The SEC inspected Bernard Madoff's operations several times without discovering his multibillion-dollar Ponzi scheme. The SEC currently oversees 11,300 investment advisers and examines about 10% of them each year, according to then article.
California is apparently trying to work smarter by targeting inspections to risk factors such as complaints "rather than simply performing them on a fixed interval."
Ms. Crawford reportedly said that NASAA will examine advisers if an individual state runs into budgetary problems. If necessary, NASAA "will go in and fund it as a special project," she said. But what are NASAA’s resources? Is not NASAA dependent on the budget-slashed state agencies?
Page Perry, LLC is an Atlanta-based law firm with over 125 years collective experience representing investors in securities-related litigation and arbitration. While past results are not indicative of future success, Page Perry’s attorneys have recovered over $1,000,000 for clients on more than 30 occasions. Page Perry’s attorneys have extensive experience in representing hedge fund investors. For further information, please contact us.
