SEC Continues To Seek To Protect Hedge Fund Investors
By James J. Eccleston, Esq.
EC Chairman Christopher Cox testified recently before the U.S. Senate Committee on Banking, Housing and Urban Affairs. His testimony left no doubt that the SEC would continue to seek protection for hedge fund investors, even after the Court of Appeals decision in the Goldstein case, which struck down the SEC's requirement that hedge funds register with the SEC and submit to inspections. That court decision, Cox testified, left a "gaping hole" in the SEC's fund regulation program, which Cox intends to rectify.
Why is the SEC so intent on regulating hedge funds? There are several reasons. First, since 2001, the SEC has brought 90 enforcement actions against hedge funds. These have involved misdeeds such as: misappropriating fund assets; engaging in insider trading; misrepresenting portfolio performance, falsifying experience and credentials; market manipulation; and illegal short selling. Let's examine some recent debacles that Chairman Cox discussed with the senators.
In SEC v. CMG Capital Management Group and Keith Gilabert, the SEC is seeking an injunction, disgorgement and civil penalties against this California hedge fund manager and investment advisory firm because they allegedly misappropriated nearly $1.7 million in funds and misled investors about the hedge fund's returns.
Likewise, in SEC v. Kirk Wright et al., the SEC obtained a temporary restraining order and other emergency relief to halt an ongoing offering fraud involving seven hedge funds by this Atlanta-based promoter and other investment advisers whom he controlled. The defendants allegedly raised as much as $185 million from up to 500 investors through their fraudulent scheme. The defendants provided investors with statements that misrepresented the amount of assets in the hedge funds and their returns. The SEC is seeking permanent injunctions, and accounting, disgorgement of ill-gotten gains and civil penalties.
Additionally, in two other matters that Chairman Cox discussed, the SEC has alleged that hedge funds engaged in insider trading. In one, the SEC has brought an action against two hedge funds, Wynnefield Partners Small Cap Value L.P. and Wynnefield Partners Small Cap Value Offshore L.P., their manager and two others. They purportedly traded in advance of a company merger agreement, resulting in illicit gains of $1.3 million. In the second matter, SEC v. Deephaven Capital Management and Bruce Lieberman, the SEC charged insider trading in connection with 19 offerings that had not been made public. The defendants have agreed to settle and, in addition to other payments, will disgorge $2.7 million in unlawful profits, plus a $2.7 million civil penalty.
Chairman Cox testified that a second reason justifying increased hedge fund regulation is that hedge funds have become much more popular. He estimates that there now are approximately 8,800 hedge funds, with approximately $1.2 trillion in assets - almost 3,000% growth in the last 16 years! Last year 2,000 new hedge funds opened. Although hedge funds represent just 5% of all U.S. assets under management, Chairman Cox testified that they account for 30% of all U.S. equity trading volume.
Third, Chairman Cox told the senators that hedge funds require more regulation because they "are generally risky ventures that simply don't make sense for most retail investors." Why? The SEC chairman recited several reasons: lack of public disclosure about the way hedge funds operate; the lack of standards for measuring a fund's valuation and its performance; the possibilities for undisclosed conflicts of interest; the unusually high fees; and the higher risk that accompanies a hedge fund's expected higher returns. Overall, hedge funds "are not investments for Mom and Pop", Chairman Cox testified.
Notably, the SEC always has had, and the Goldstein court opinion did not disturb, the ability to bring enforcement actions against hedge funds and their advisers under the antifraud, civil liability and other provisions of the federal securities laws. However, more needs to be done. Chairman Cox outlined a series of efforts that the SEC plans to undertake in the near future. One includes revisiting the definition of "accredited investor" for purposes of qualifying to purchase a hedge fund. That definition, Chairman Cox told Congress, is "decades old" and "not only out of date, but wholly inadequate to protect unsophisticated investors from the complex risks of investment in most hedge funds."
Stay tuned!
_______________________________________________________________________
James J. Eccleston is a securities attorney, representing customers as well as brokers and brokerage firms nationwide in arbitration, litigation and regulatory matters. He maintains an informative website at www.FinancialCounsel.com. He is an equity partner with Shaheen, Novoselsky, Staat, Filipowski & Eccleston, and can be reached at 312-621-4400.
|
Download Acrobat Reader