Time is ticking away for US hedge funds to prepare for their first-ever government regulation, but lawyers and managers say that many are spending hours working on ways to escape the additional scrutiny. Beginning next year, thousands of the now loosely regulated and often secretive investment funds must tell financial regulators more by submitting to audits, adopting a code of best business practices and appointing a compliance officer.
Since the Securities and Exchange Commission adopted its new rule for hedge funds last year, registering as an investment adviser with the government has become an inevitable fact of life for thousands of hedge funds.
But plenty of managers may also steer clear of the costs and headaches they say will come with more oversight by taking advantage of one loophole the government left open.
"Virtually every one of our clients is now evaluating whether to register or to take steps to avoid it," said George Mazin, a partner at law firm Dechert LLP.
Funds with more than $30 million in assets and 15 or more clients will have to fill out the paperwork and thousands of managers fall into this category, industry experts said.
However, hedge funds that agree to keep their clients' money for at least two years are not required to submit to the registration process.
Suddenly, a large number of managers are considering much longer lockup periods.
By hanging on to their clients assets for longer, the managers can avoid documenting their investment procedures and sticking to everything in that manual.
They can also avoid certain compliance training, having to keep reams of data for auditors and testing and monitoring their employees more closely.
All of these things cost time as well a considerable amount of money, industry experts said. Law firms charge $30,000 for tailoring a manual to their client's fund and compliance firms charge about $50,000 per year for spending several days a month at a hedge fund making sure all documents are in order.
"Some people are looking to avoid registration because the costs are not insignificant," said Emmett Ryan, director of hedge fund services at compliance firm Buchanan Associates, who will meet with 11 hedge funds in the next two weeks to go over the basics of preparing for next February's deadline.
"A lot of people come see us to shop around and I would not be surprised if the two-year lockup periods now becoming popular didn't find their roots in the registration process," he added.
Already, roughly one third of the world's estimated 8,000 hedge funds are registered with regulators, and only a certain type of fund will be able to take advantage of the loophole, lawyers and managers said.
"A manager has to have delivered really good returns to be able to tell clients that they won't see their money for two years at a time many of the pension funds are demanding to get their money back every month, if they don't like the hedge fund's performance," said a manager, who asked not to be named.
The loophole "is an avenue that is available and clients seem eager to take advantage of it," Dechert's Mazin said.
The SEC, however, has already signalled that it won't tolerate any abuse of the lockup provision.
Paul Roye, director of the SEC's Division of Investment Management, warned several times that the rule might be redefined if significant evasion is seen.
"The SEC is determined and they are not going to be spooked or made a fool of," said Charles Gradante, principal of the Hennessee Group, which helps clients invest in hedge funds.
"The SEC isn't going to allow a loophole to impact the kind of registration they want. If it happens, they will just close it off."
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