Hedge funds exploit a loophole

Sep 26, 2005 @ 12:01 am

By Jeff Benjamin

SOUTHAMPTON, BERMUDA - Months before a controversial rule change is slated to go into effect, some hedge fund managers are exploiting a loophole that allows them to evade regulatory safeguards aimed at protecting investors.

Faced with the prospect of registering with the Securities and Exchange Commission as investment advisers, the managers are extending their funds' lockup periods. The rule change, which is scheduled to take effect in February, allows hedge fund firms to skirt SEC audits and inspections by locking up the money of its investors for more than two years.

"It was totally predictable that hedge funds would start using longer lockup periods," said SEC Commissioner Cynthia Glassman, who opposed the hedge fund registration rule. "I'm not at all surprised; I said this was going to happen."

Longer lockups are raising eyebrows among many in the $1 trillion hedge fund industry. Some worry that the maneuver will ruffle feathers at the SEC.

"I'm seeing it being done by hedge funds, and frankly, you don't thumb your nose at regulators," said Jeff Heely, chief executive of Heely Capital LLC, a San Anselmo, Calif.-based family office that invests in hedge funds.

More oversight ahead?

Extended lockups might also result in even more regulatory oversight of the hedge funds industry, Mr. Heely said.

"If you want to be in this business, you should be prepared to operate like a business," he said. "The SEC says they want to see what you're doing, and for hedge funds to try and be clever only asks for more regulations."

As lockup periods are private agreements between hedge fund firms and investors, there's no way of knowing exactly how many hedge funds are extending them.

But it was no secret last week at the MarHedge World Wealth Summit here that some managers are taking what might appear to be an easy way out.

"There have been noises out of the SEC that suggest they have noticed the trend and they don't like it," said Edwin Laurenson, partner at the New York law firm of McDermott Will & Emory LLP.

Phillip Goldstein, who manages the $73 million Opportunity Partners LP hedge fund from his home in Pleasantville, N.Y., hasn't extended his fund's lockup.

But he did file a lawsuit earlier this year charging that the SEC overstepped its authority by requiring hedge fund registration.

"Assuming you're considering your options for not registering, extending the lockup is an option worth considering," Mr. Goldstein said.

He isn't worried about the SEC's response to longer lockups.

"The SEC has said they're going to scrutinize it, but I think they're just blowing smoke," Mr. Goldstein said. "It seems to me the SEC already has its hands full."

He may have a point.

Overextended agency

Just last week, Congress' Government Accountability Office released a study concluding that the SEC already is overextended. The added responsibility of monitoring hedge fund advisers likely will result in large gaps in the commission's ability to protect investors, it said.

Of the more than 8,000 hedge funds, it's estimated that about half have at least $25 million under management and more than 14 U.S. investors, the minimum requirements for SEC registration.

Lockup periods, which typically are set at one year for most hedge funds, apply only to the initial investment into a fund. Beyond that period, most hedge funds allow investors to withdraw money on a quarterly or monthly basis.

To be sure, a longer lockup doesn't necessarily mean that a hedge fund is trying to dodge registration, said James R. Hedges IV, president of LJH Global Investments LLC in Naples, Fla.

While some managers "are trying to steer clear of what they perceive to be an unnecessary registration process," said Mr. Hedges, a longer lockup usually translates into more stability for investors.

More stability

"Some of the best hedge funds out there have longer lockups," he said. "As an investor, I'm interested in funds that have a more stable asset base and a more stable investor base."

The downside of the longer lockups, Mr. Hedges added, is that some investors won't be interested, and that could make it more difficult to attract assets.

Among the market of potential investors likely to shy away from longer lockups is the fast-growing fund-of-hedge-funds industry, which is estimated at more than 1,800 funds and approximately $500 billion.

Many offshore funds of hedge funds invest in U.S.-based hedge funds that are wrapped in various structured products, including capital guarantees, and that are sold to non-U.S. investors.

Most structured products require liquidity, according to John Van, chief financial officer with Van Hedge Fund Advisors International Inc. in Nashville, Tenn.

"There's a great disincentive for imposing these kinds of lockups, because they will not be considered for structured products," he said. "The industry is actually moving toward greater liquidity, because investors don't really want to see longer lockups," Mr. Van said.


What do you think?

View comments

Upcoming event

Sep 24


Diversity & Inclusion Awards

Attend an event celebrating diversity and inclusion as well as recognizing those who are leading the financial services profession in this important endeavor. Join InvestmentNews, as we strive to raise awareness, educate and inspire an... Learn more

Most watched


Young advisers envision a radically different business in five years

Fintech and sustainable investing are two factors being watched closely by some of the 2019 class of InvestmentNews' 40 Under 40.


Young professionals see lots of opportunity to reinvent the advice experience

Members of the 2019 InvestmentNews class of 40 Under 40 have strategies to overcome the challenges of being young in a mature industry.

Latest news & opinion

Target-date fund design may be wrong for retirees

Researchers suggest the funds don't adequately hedge against sequence-of-returns risk in retirement.

InvestmentNews' 2019 class of 40 Under 40

Our 40 Under 40 project, now in its sixth year, highlights young talent in the financial advice industry. These individuals illustrate the tremendous potential of those coming up in the profession. These stories will surprise, entertain, educate and inspire.

New Jersey fiduciary rule: Pressure leads to public hearing, comment deadline extension

Industry push results in chance to air grievances on July 17 and another month to present objections.

Galvin to propose fiduciary rule for Massachusetts brokers

The secretary of the commonwealth is proposing a fiduciary standard in response to an SEC investment-advice rule he views as too weak.

Summer reading recommendations from financial advisers

Here are some books that will keep you informed and entertained during summer's downtime


Hi! Glad you're here and we hope you like all the great work we do here at InvestmentNews. But what we do is expensive and is funded in part by our sponsors. So won't you show our sponsors a little love by whitelisting investmentnews.com? It'll help us continue to serve you.

Yes, show me how to whitelist investmentnews.com

Ad blocker detected. Please whitelist us or give premium a try.


Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print