While the average person might hear the word “unregulated”
tossed around in regards to hedge funds inside of the United States, this is
technically untrue. Yes, hedge funds are considered private investments, and
therefore investors and hedge fund managers (either as partnerships or as a
company) do not have to register with the SEC (Securities and Exchanges
Commission). However, there are some exceptions to that rule, and most
importantly, hedge funds cannot legally be fully unregulated.
First of all, some of the multiple exceptions to hedge funds
not being required to report information to the Securities and Exchanges
Commission include:
- Even though a fund can have unlimited investors, if they number more than four hundred and ninety-nine in total, they must register their securities with the SEC, according to the Securities Exchange Act of 1934.
- If a hedge fund wants to advertise or make public offerings, they must sell said offerings under the private offerings rule of SEC. This requires either filing a registration statement with SEC, or adversely following the private placement rules under the Securities Act of 1933.
- If a hedge fund adviser who is registered with the SEC wishes to charge a performance or an incentive fee, all investors must meet the standards for qualification set forth by the Investment Advisers Act of 1940 Rule 205–3.
As for other regulation that hedge funds are subjected to,
compliance with the SEC is only the beginning. One of the most efficient ways
to keep track of hedge funds, and to try and keep a handle on potential fraud,
is to make stringent rules for investors. Investors must meet a specific set of
criterion (and some of this will vary depending upon state) before they can
begin to invest. For example, investors who meet a qualified purchaser
qualification will have five million dollars as a bare minimum in investment
assets. An investment company would need a minimum of twenty-five million
dollars in order to qualify.
Even though the regulations for hedge funds are quite lax compared
to some other types of investments – and keep in mind this is because hedge
funds are considered private investments – they are indeed regulated. Fraud is
a very real possibility in any investment scenario, and when such large sums
are dealt with in hedge funds, schemes and fraud can occur and must be
prevented. There have been several high profile cases of hedge fund schemes in
the news over the last several years, and that has drawn both media and public
attention onto the fact that hedge funds have a very unique regulatory status.
In fact, there have been several attempts (mostly by the Securities and
Exchanges Commission) to bring more regulation to hedge funds, including a rule
change that required all hedge fund advisers to register under the Investment
Advisers Act. This rule change was subsequently contested, overturned, and sent
back to the SEC for review. Some are eager to regulate hedge funds, and some
continue to hotly contest the practice.
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