Wed Jul 14, 2004

By Kevin Drawbaugh

WASHINGTON, July 14 (Reuters) - A divided U.S. Securities and Exchange Commission on Wednesday moved closer to requiring that hedge fund advisers must register with the agency as it moves to crack down on a fast-growing, $850 billion business.

Unaccustomed to regulatory limits, hedge funds had fought hard to block the SEC, but the commission voted 3-2 to advance a proposed registration rule to a 60-day public comment period. A final SEC vote will come later, probably in early fall.

SEC Chairman William Donaldson, a Republican, sided with Democrats Harvey Goldschmid and Roel Campos to back the measure, which would require hedge fund advisers to give the SEC basic information about themselves.

In opposition were Republican commissioners Paul Atkins and Cynthia Glassman, who said the proposal is "premature and represents another example of form over substance."

The Senate Banking Committee is scheduled to hold a hearing on Thursday on hedge fund regulation. Donaldson will testify.

Hedge funds are capital pools that were initially popular with financial institutions and the rich, but increasingly are being promoted also to the so-called "mass affluent" market.

Numbering about 6,000, the funds are free to invest in almost any market with little oversight. They are expected to control assets topping $1 trillion in five to 10 years.

There have been more than 85 SEC enforcement actions involving hedge funds over the past five years. The funds were deeply involved in the improper share trading scandals that recently rocked the $7.6 trillion mutual fund business.

Donaldson said the SEC lacks adequate information to get in front of the hedge fund issue -- a step he views as vital to getting the sometimes slow-footed SEC to see "around the corner" to any future hedge fund problems.

"The hedge fund industry is a $1 trillion corner along Wall Street, with 'warning signs' flashing at us. We simply can't afford to continue to walk by and ignore it," he said.

Investment in hedge funds by pension funds that handle the retirement savings of middle-income Americans is broadening the base of those exposed to hedge fund risks, Goldschmid said at a meeting where the normally collegial commissioners clashed.

"Hedge funds are in a Wild West atmosphere," Goldschmid said. "We know too little about what's going on ... There is more fraud and it's hard-core fraud."

Positions staked out at the meeting by the commissioners suggested the upcoming final vote may also go 3-2, but intense opposition lobbying will continue through the comment period.

"The case for mandatory investment adviser registration of hedge fund managers has not been made, and we expect that, once all the facts are in, the proposal will not be adopted," said John Gaine, president of the Managed Funds Association, the industry's Washington lobbying group.

Almost two-thirds of the 100 largest hedge funds are already registered with another U.S. government agency, the Commodity Futures Trading Commission. About a quarter of hedge fund managers are already registered as investment advisers with either state authorities or the SEC.

At present, only individual investors with net worth of at least $1 million, or annual income of $200,000 or more for two consecutive years are eligible to invest in hedge funds. (Additional reporting by Mark McSherry in New York, Svea Herbst-Bayliss in Boston)

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