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Roye Reviews New Regulatory Framework for Hedge Fund Advisers

Paul Roye, the director of the SEC's Division of Investment Management, spoke at the January 12 Managed Funds Association Educational Seminar in New York where he reviewed the SEC's new rule requiring the registration of hedge fund advisers. Roye said that registration of hedge fund advisers under the Investment Advisers Act was the least intrusive form of regulation the SEC could take to address its concerns about the hedge fund industry.

Roye noted that the SEC provided a lengthy transition period for the registration of hedge fund advisers, until February 1, 2006. That should give them plenty of time to address any technical issues that might arise, he said. Roye reviewed the registration process through the SEC's electronic investment advisory registration depository.

Part II of the registration form, the brochure that contains information about business practices, fee arrangements and conflicts of interest, is not currently required to be filed with the SEC, but must be provided to clients, including hedge fund investors. Roye said the Division is likely to recommend that the SEC revise Part II before next February so that it can be electronically filed and disseminated through the SEC's Web site.

Once hedge fund advisers are registered with the SEC, they must have in place compliance policies and procedures, a code of ethics and a chief compliance officer. Roye said that most hedge fund advisers probably already have compliance procedures in place since they owe a fiduciary obligation to their clients. Others may have adopted the measures outlined in the MFA's report on sound practices for hedge fund managers that was published in 2003.

Roye urged hedge fund advisers to review the SEC's rule requirements when preparing their compliance policies and procedures to ensure that they technically satisfy the regulatory obligations. During the process, Roye also encouraged advisers to perform a risk-based assessment of their firm's operations to ensure that the policies and procedures are designed to manage that firm's conflicts of interests for the protection of their clients.

Roye cautioned advisers against adopting "off the shelf" compliance manuals or codes of conflicts. This can be a dangerous practice, he explained, since a single approach may not work given the differing sizes, structures and operations of advisory firms. The other danger is that an adviser may adopt generic compliance policies and procedures that obligate the firm to adhere to specific policies or procedures that are not appropriate or necessary for that firm's circumstances.

With respect to the chief compliance officer requirement, Roye noted that firms do not have to hire an outside person, nor does the person have to serve as a full-time compliance officer. The rule provides the flexibility to permit a firm to design the compliance officer position that is appropriate for the firm's needs.

Roye acknowledged some hedge fund advisers' concerns about the SEC's examination process. While no one likes having someone look over their shoulder, Roye said that the reviews can impose a healthy and constructive discipline. He noted that Chairman William Donaldson has appointed an investment adviser task force to examine the use of technology to improve the SEC's efficiency and effectiveness in overseeing investment advisers.

Roye also pledged that the staff will work with the CFTC in implementing the registration rule and will coordinate its oversight going forward to eliminate unnecessary duplication for dually registered investment advisers.