New research from Greenwich Associates suggests that the SEC's short-lived experiment with hedge fund registration may end up having a lasting impact.
Despite the fact that nearly 20% of the registered hedge funds participating in a recent Greenwich Associates study plan to de-register in the wake of a federal appellate court ruling striking down the SEC registration order, a larger proportion of hedge funds said they plan to retain new compliance processes, practices and staffing implemented in order to meet registration requirements.
More than 30% of the hedge funds surveyed by Greenwich Associates said that, in order to comply with the original SEC registration requirement, they expanded staffing, largely in their compliance departments. 'For most funds, increased staffing was only part of the changes brought on by the regulator,' says Greenwich Associates consultant Peter D'Amario. 'Hedge funds also upgraded technology, implemented operational 'best practices' and initiated compliance monitoring procedures.'
Greenwich Associates consultant John Feng continues: 'Virtually all of the hedge funds participating in the Greenwich Associates study said they plan to retain newly employed staff regardless of the final decision regarding SEC jurisdiction. Almost two-thirds of respondents said they planned to proceed with mock inspections or year-end compliance reviews even if the registration requirement were eliminated. The development of procedures and practices like these may prove the ultimate legacy of the SEC's brief fling with mandatory registration.'
Registration Accelerates Institutional Reforms
The SEC's hedge fund registration requirement took effect in February 2006. In June, a federal appellate court ruling overturned the policy. In order to gauge the hedge fund response to the court-ordered reversal, Greenwich Associates surveyed 47 hedge funds between July 18 and August 3, 2006 - before the SEC's August 7 announcement that it would not appeal the court ruling ending the registration requirement. More than three-quarters of respondents were U.S. hedge funds.
Almost 70% of the hedge funds surveyed were registered with the SEC. A large portion of the funds that did not qualify for an exemption - more than 27% - say they will maintain their registration status even if the requirement is permanently eliminated. "More than 50% of those respondents say they are unsure as to how they will proceed with regard to registration," says Greenwich Associates' Hedge Fund Specialist Karan Sampson.
Of course, one of the biggest considerations for any hedge fund in determining whether to maintain its current registration status is cost. For hedge fund managers, the cost of registration and compliance has been considerable: three-quarters of the hedge funds participating in the survey said changes in regulation have increased their costs.
However, for most hedge funds, the reforms made as part of the registration process did not come out of the blue; rather, they were steps that many funds were considering anyway as they evolved into more complex firms actively seeking institutional assets. As Karan Sampson explains: 'The SEC policy has accelerated this process of institutionalization; it did not impose it. Many of the changes implemented in connection with registration make sense in terms of hedge funds' courtship of institutional assets. For pure business reasons, many of them will outlive the aborted policy.'
The best example: the registration label itself. When asked why they might decide to remain registered in the absence of the requirement, hedge funds noted that registration served as a useful marketing tool and that 'flip-flopping' on registration would send the wrong message to clients. Hedge funds - especially larger funds that would presumably be more focused on attracting institutional assets - expressed similar views about compliance and operational 'best practices' and staffing.
'Regardless of the court ruling and the SEC's decision to forgo its appeal, hedge funds are evolving and creating structures and business models very much in line with those envisioned by the SEC,' says Greenwich Associates consultant Tim Sangston. 'They are keeping the compliance officers they hired during the registration process, they're making sure they conform to best practices, and many are going to retain their registered status. These decisions have indeed been imposed on hedge fund managers by an external source, but that source is the checklist of demands from institutional investors as opposed to just a list of requirements developed by regulators.