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Campos Defends SEC's Hedge Fund Adviser Rule

Commissioner Roel Campos, in a speech that preceded the court of appeals decision overturning the SEC's hedge fund adviser rule, discussed how the SEC is monitoring the market's ability to discipline hedge funds. Campos advised that the SEC is focusing its attention on broker-dealers' exposure to hedge fund risks and its implication for the financial markets. The court's decision was issued June 23. Campos' remarks at a June 14 hedge fund conference were posted on the SEC's Web site.

Campos talked about the various strategies that may be employed by activist hedge funds, each of which has the potential to help or to hurt the companies in which they take large positions. Hedge funds are not traditional institutional investors, he said, and are not constrained by the cultural and political pressures that traditional institutional investors face. As their strength increases, Campos said that hedge funds' ability to wreak havoc on issuers and the market also grows. In his view, the primary concern about hedge funds is their potential to change the level or nature of risk in the markets and financial institutions, given their significant role in the marketplace.

Most federal officials appear to believe that the market is the best force for keeping hedge funds in line, according to Campos. This approach focuses on monitoring operational risk and infrastructure failures, he explained, as well as taking a principles-based approach to any regulation. Campos noted that the SEC's staff examines broker-dealers under its consolidated supervision program, including unregulated affiliates and the holding company where financing transactions with hedge funds may occur. Since the SEC's hedge fund adviser rules went into effect, the SEC has also pursued an active examination and inspection program.

Campos reported that some in the industry have complained about the length of the hedge fund examinations and the document requests in connection with the examinations. He noted that the examinations are designed to detect compliance deficiencies and violations that may impact investors, so an examination will take as long as needed to explore the categories of risk that have been identified. The length of the examination will also reflect the degree of complexity, he advised.

Campos said that the review process has been interactive and ongoing with industry involvement. In response to concerns that the staff was using information gathered in examinations to craft additional rules, Campos said he has seen no evidence of any need for additional regulation. There are no "secret plans" for the further regulation of hedge funds, he said.

In response to critics who argued that the hedge fund adviser rule would not uncover more fraud, Campos said that was not its sole purpose. The SEC already has the ability to investigate fraud at any hedge fund, he explained. The rule was intended to bring greater transparency to a rapidly growing industry that is affecting an increasing number of investors, he said. The examinations may deter fraud, in his view, and may also focus the industry on adopting best practices. Campos maintained that the industry should support examinations in order to establish high standards and a good reputation.

Campos said the limited regulatory framework that was adopted by the SEC was the right approach and that the SEC would continue to work with the hedge fund industry for the protection of investors. After the appeals court's decision, SEC Chairman Christopher Cox instructed the staff to evaluate the decision and provide alternatives for the Commission's consideration. The SEC will work with the members of the President's Working Group on Financial Markets to evaluate the systemic market risks and the retail investment issues that hedge funds pose in the world's financial markets, according to Cox.