Sign up today and take advantage of member-only content — the kind of timely, cutting edge industry insight that only Money Management Executive can deliver.
  • Exclusive Online Only Content
  • Free Daily Email News Alerts
  • Asset Management Blogs

SEC Could Target Hedge Funds in 2006: Fee Cuts Should Continue; Job Outlook Promising

And so begins a new year in the money management industry, fraught with anxiety over whether the nation's capital markets will bounce back from a relatively flat 2005, or if December's dreaded inversion of the bond yield curve and what is surely to be further tightening of short-term interest rates are a harbinger of darker days to come.

Whatever the markets might hold in 2006, experts say, this much is for sure: Regulators will continue and perhaps even expand the intensity of their police work, particularly in the hedge fund area; the fee reductions that began in post-scandal 2003 and accelerated in 2004 are likely to continue, albeit a bit subdued; and the business of compliance will be the primary job creator in the industry yet again this year.

Led by the ever-expanding hedge fund industry, however, regulators could play an even larger role in 2006, said Mallory Factor, an investor relations consultant at Mallory Factor in New York and chairman of the Free Enterprise Fund, a Washington lobbyist.

"Bureaucrats will wrap the same coils of red tape that have snared the mutual fund industry around the hedge fund industry," Factor declared. "Hedge funds are red meat, and Beltway regulators are licking their chops."

The first step in closer regulation of the hedge fund industry is the Securities and Exchange Commission's new advisor registration rule, a measure it says was prompted by the leading role hedge funds played in the mutual fund scandal. Registration, which is due by Feb. 1, means the SEC can conduct examinations and, as the regulator says, "identify compliance problems at an early stage and provide a deterrent to unlawful conduct."

Registration would additionally force most of the nation's 8,000 hedge funds to adopt compliance procedures and, the SEC says, keep convicted felons from running funds. The regulator is further hoping that registration would prevent the "retailization" of hedge funds by giving it the authority to enforce rules that say hedge fund investors must have a minimum net worth of $1.5 million.

And in the coming months, a Washington appeals court is expected to deliver its opinion on a lawsuit seeking to overturn the rule.

But Factor doesn't doubt that the SEC will be successful in curbing the proliferation of hedge funds, which are already reaching more everyday investors through funds-of-hedge funds and mutual funds that employ an absolute return investing style.

"Heavy-duty regulation gives regulators their jobs, it gives them money, and it gives them power," he said. "They're bullish on hedge funds right now, and what's bullish for the bureaucrat, is bearish for everyone else."

There are, however, a number of issues far lower on the industry's radar that will receive greater attention from the SEC in 2006, experts say. For example, there's an SEC rule proposal regarding the electronic delivery of proxy statements by equity issuers that could bleed over into the mutual fund industry. The rule's comment period ends on Feb. 13.

"We're keeping a very close eye on it," said David T. Copenhafer, director of EDGAR services at Bowne & Co., a New York-based printer of financial information for mutual funds. "It applies to equity issuers, but the comments will determine where the SEC goes with the final rule."

For funds, it could portend an initiative towards the electronic delivery of everything from prospectuses to semi-annual and annual reports.

The SEC estimates that equity issuers spend $535 million in postage fees and printing costs alone to distribute paper proxy materials.

In addition, Copenhafer said, the SEC will likely accelerate internal efforts aimed at making the regulator more technically savvy. In particular, he thinks the SEC will push for greater use of XBRL, a rapidly emerging software code that would enable investigators to electronically conduct reviews of mutual fund financial information and marketing materials. For example, it could quickly and efficiently scan a fund's portfolio holdings to determine if those stocks match its stated investment style, and how quickly those investments are turned over.

"It's a tough nut to crack, though," Copenhafer added. "It's a very complicated program. The SEC has only received about 18 or 19 filings in XBRL. I don't believe any mutual funds have submitted a filing using XBRL yet, but the SEC would love to see it."

Fee reductions should also continue this year, but at a more measured pace, said Kip Price, head of Global Fiduciary Review at New York fund tracker Lipper. Many fund complexes reduced their fees to keep investors on board after the scandal. In 2006, reductions will occur largely through the merging away of smaller funds that were begun during the product push of the last bull market. Assets have also been flowing to lower-cost fund complexes, like Fidelity, Vanguard and American Funds.