DETROIT - Against all odds, Phillip Goldstein is pushing ahead with a lawsuit challenging the Securities and Exchange Commission's authority to require hedge fund managers to register as investment advisers.
Mr. Goldstein, manager of the $73 million hedge fund Opportunity Partners LP, is set to square off against the SEC Dec. 9 over the controversial rule change that will shed more light on the $1 trillion hedge fund industry.
The case, which comes as many hedge funds managers are bracing for the Feb. 1 registration deadline, is being closely watched for its potential to stop the SEC in its tracks.
"I feel like we have a good case - a very good case," said Mr. Goldstein, who sued the SEC in December 2004.
The SEC declined to comment on Mr. Goldstein's case.
But there are many in the hedge fund industry who are not pinning their hopes on a victory for Mr. Goldstein.
"If the SEC wants oversight in a particular jurisdiction, they're going to get it," said Jeff Joseph, managing director of the alternative investments unit of Rydex Global Advisors Inc. in Rockville, Md.
Although there's a chance Mr. Goldstein's challenge could derail the rule change, the most prudent course of action is to prepare to meet the registration deadline, said John Van, chief financial officer of Van Hedge Fund Advisors International Inc. in Nashville, Tenn.
"If I were a hedge fund manager, I wouldn't wait to register based on this lawsuit," he said. "The SEC expects the registration process to begin in December, and this hearing isn't set to start until December."
To some, the lawsuit is little more than a desperate attempt at finding a loophole.
"I think the lawsuit is amusing," said Charles Gradante, managing principal at Hennessee Hedge Fund Advisory Group LLC in New York.
"I'm not a lawyer, but I know that the regulatory process is something that is going to happen here," he said. "Finding loopholes will be fruitless, and they will not alter the spirit of what the SEC is trying to attempt."
Mr. Gradante, like most in the hedge fund industry, is not a proponent of hedge fund registration. But it's too late to stop it from happening now, he said.
"This is like dealing with the Internal Revenue Service," he said. "When they find a loophole, they plug it, and then they charge you the back taxes."
Mr. Goldstein, who manages Opportunity Partners out of his home in Pleasantville, N.Y., doesn't agree with the proposal. In fact, he intends to hold off from registering for as long as possible, he said.
The lawsuit focuses on the SEC's authority to count the investors in a particular hedge fund as individual clients of the hedge fund manager.
According to the SEC's rule, hedge fund managers with more than $25 million under management and more than 15 clients are required to register as investment advisers.
The suit contends that by counting individual investors, the SEC is reinterpreting a 1987 Supreme Court decision that defined a hedge fund as a single client.
"The primary question is, does the SEC have the power to interpret the term 'client' for people who don't receive personalized advice directly from the hedge fund manager?" said Greg Keller, the attorney representing Mr. Goldstein with Chitwood Harley Harnes LLP in Great Neck, N.Y.
"The SEC is saying they want to expand their already insufficient regulatory system to encompass hedge funds, and the only way they could do that was to look through [the hedge funds] to the individual investors," he added. "If we're correct - and we think we are - the SEC does not have the statutory authority to consider as clients persons who don't receive direct or personalized advice from a hedge fund adviser."
The SEC's ability to effectively oversee hedge funds has become a parallel component of the overall debate.
In too deep
More than year ago, in her opposition to the rule, SEC Commissioner Cynthia Glassman pointed out that as a result of the rule change, the SEC didn't have the resources to oversee the influx of investment advisers. She also suggested that the SEC's auditors would not be familiar with some of the more complex investment vehicles used by some hedge fund managers.
Even Mr. Joseph, who thinks hedge fund managers should conform to the registration process, believes that the SEC is getting in over its head when it comes to hedge funds.
"I personally don't think they can do it," he said. "They don't even have the bandwidth to get through the financial adviser market. How are they going to audit another 3,000 to 5,000 registrants?"
For some hedge fund managers, the idea that the SEC is ill equipped for the expanded oversight is a mixed blessing.
"I'm hoping the registration rules will scare some hedge funds away and draw more assets our way," said Larry Eiben, who manages a $50 million hedge fund at TFS Capital LLC in Richmond, Va.
He has been registered since 1997 and has yet to see the benefit in terms of attracting investors. Mr. Eiben did, however, describe his most recent SEC audit as "the worst week of my life."
"I think most hedge funds probably have no idea what's coming in terms of the record-keeping and disclosure requirements," he said. "But I am liking all this, because it's going to lower the likelihood that we'll see another audit anytime soon."