SEC adopts anti-fraud rule for hedge fund managers

The Securities and Exchange Commission has voted unanimously to adopt a new anti-fraud rule under the Investment Advisers Act that will clarify the ability of the US financial regulator to bring enforcement actions against managers of hedge funds and of other traditional and alternative investment vehicles that deceive or mislead investors, deliberately or otherwise.

The five commissioners have deferred for the time being a proposal they introduced last December that would raise substantially the level of investible assets required to qualify as an accredited investor eligible to invest in hedge funds. Although the proposal was greeted with strong public criticism, SEC chairman Christopher Cox says the commission plans to take a decision on implementing the changes soon.

The SEC was prompted to introduce a new rule against fraud because of some uncertainty about the authority of the regulator over hedge funds raised by a decision of the US Court of Appeals last year.

The court upheld a complaint from hedge fund manager Philip Goldstein that the SEC exceeded its powers when it introduced a rule requiring investment advisers to register with the commission if they had more than 14 clients. The SEC rule was struck out in part because it defined clients as the individual investors in a fund, rather than the fund itself, a definition that the court rejected.

The decision created the possibility that the SEC could not taker action against managers whose fraudulent conduct damaged the interests of investors because the latter might not be considered clients of the investment manager. The new rule closes the loophole by explicitly referring to investors and prospective investors rather than clients.

The rule will come into effect 30 days following its publication in the Federal Register, a process that is expected to take around a week following approval by the commission.

'This rule applies to investment advisers not only of hedge funds, but also of private equity funds, venture capital funds, and mutual funds,' says Cox. 'Collectively, these funds hold trillions of dollars of investors' assets and play an important and growing role in our capital markets. The rule will give the commission an important tool to help us police this market - to deter misconduct and to call to task those who breach their obligations to investors.'

The new rule will make it a fraudulent, deceptive or manipulative act, practice or course of business for an investment adviser to a pooled investment vehicle to make false or misleading statements to, or otherwise to defraud, investors or prospective investors in that pool.

The rule will apply to all investment advisers to pooled investment vehicles, regardless of whether the adviser is registered under the Advisers Act. Pooled investment vehicles will include any investment company and any company that would be an investment company but for the exclusions in Sections 3(c)(1) or 3(c)(7) of the Investment Company Act.

Section 3(c)(1) of the act gives an exception to companies whose voting securities are owned by 100 people or fewer, while Section 3(c)(7) exempts from the definition of investment company any issues whose securities are held solely by qualified investors.

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