Hedge Funds in the Spotlight

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Hedge Funds have received attention recently in the press and from state and federal regulators, resulting in attempts at increased regulation of the hedge fund industry, for the following reasons:

i. Growth of the Hedge Fund Industry

Perhaps if hedge funds occupied a smaller corner of the market, they would be the subject of less skepticism and concern. However, hedge funds have shown a tremendous growth in the last ten years. In 1993, it is estimated that there were approximately 400 hedge funds with aggregate assets of $50 billion dollars. Today, the number of hedge funds has reportedly grown to an estimated 6,000-8,000 with total assets of $600 billion to $1 trillion dollars. To critics, these assets represent a tremendous amount to be invested in a largely unregulated segment of the securities industry.

ii. Increased Interest/Participation of Institutional Investors

The growth in investor interest in hedge funds can be attributed, in some measure, to increased interest of institutional investors, such as pension plans, endowments, and foundations. There is word that insurance companies may also be getting into the mix. These investors are looking for ways to diversify their portfolios to include instruments which stress flexible market approaches to insure an absolute return in either a rising or falling market. The concern is that unqualified investors who would not normally have access to hedge funds will be involved indirectly in hedge fund investments through pension plans or other institutional means, without the protection registration provides.

iii. Retailization

The general public, especially middle class investors, have shown a greater interest in investing in hedge funds. This interest comes at a time when, through the use of the internet, the largely unregistered hedge funds can solicit a large segment of the population. This practice is often referred to as the "retailization" of hedge funds. Along the same line, as mentioned above, there has been concern that many unqualified investors will be involved in hedge fund investments indirectly through pension plans and profit sharing or retirement programs. This same concern also pertains to the growth of "funds-of-funds," which are registered investment companies that invest all, or substantially all, of their assets in an underlying pool of hedge funds. Regulators and critics feel that these unsophisticated, and therefore unqualified, investors need further protection than current securities law provide.

iv. Alleged Increasing Instances of Hedge Fund Fraud

Regulators would claim that the growth in the number of hedge funds appears to coincide with the increased number of SEC enforcement actions against hedge funds. In addition to an increased number of SEC enforcement actions for fraud, hedge funds were also implicated in the market timing scandals involving mutual funds.

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