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Atkins Continues Criticism of Hedge Fund Adviser Registration Rule

Commissioner Paul Atkins, in an address to the Managed Funds Association, said the SEC is struggling to prepare for the registration of hedge fund advisers just as they may be preparing for registration with the SEC. Atkins said the SEC has neither the resources nor the expertise to oversee all of the potential new registrants, which he estimated as up to 1,260 new registrants, which would increase the pool of registered advisers by as much as 15%. In Atkins' view, the SEC's mandates are no substitute for the implementation of consistent controls by hedge fund advisers. He commended the MFA for publishing sound practices for the industry which provide guidelines on risk monitoring, valuation, business continuity and disaster recovery planning.

Atkins reported that the examination staff consists of about 500 examiners who oversee 8,000 funds and 8,000 investment advisers. He referred to a recent GAO report that raised concerns about the SEC's inability to conduct examinations of all mutual funds within a reasonable period of time. The GAO also identified weaknesses in the quality control measures in the Office of Compliance Inspections and Examinations, largely due to staff shortages. The SEC's hedge fund adviser registration requirement aggravates an already difficult situation, according to Atkins.

Atkins noted that the newly registered hedge fund advisers may present unique challenges to the examination staff. While many of the elements an examiner looks at are common to any registered money manager, Atkins said the new registrants may use complex structures that the staff has not encountered before. The staff may be tempted to use a one-size-fits-all approach to its examinations, Atkins said, but it may not work in the hedge fund context in areas such as valuation techniques and risk management. He supports OCIE's efforts to learn from MFA and others with hedge fund experience and hopes the training will enable the staff to discern the difference between actual problems and departures from the "standard" approach.

Atkins is concerned that the SEC's decision not to require the registration of hedge fund advisers that do not permit redemptions within two years will provide an incentive for advisers to lengthen their lock-up periods. The two-year lock-up is intended to distinguish hedge funds from venture capital and private equity funds, he explained, but it may make it harder for investors to recover their money from fraudulent advisers.

Atkins said the SEC is poorly positioned to prevent problems from happening or even from discovering them once they have occurred. The SEC often relies on disgruntled investors, former employees or suspicious third parties to alert it to problems. He believes the MFA's sound practices guidelines offer more comfort to investors than registration with the SEC.

Atkins hopes to see a renewed, receptive attitude to a cost/benefit analytical approach to regulation under the leadership of Chairman Christopher Cox. He also hopes that a reasoned approach will extend to the implementation of the hedge fund adviser rule. Now that the rule has been adopted, Atkins said the SEC should work more closely with its regulatory counterparts to assess their collective data about hedge fund advisers. The SEC should also work with foreign regulators to better understand the interaction of the new requirements with foreign regulatory frameworks. Any systemic concerns should be addressed by the President's Working Group, he added.

Atkins cautioned hedge fund advisers not to assume that the staff shortage at the SEC will keep them off the examination staff's radar screen. Instead, he urged hedge fund advisers to take this opportunity to improve their operations by adopting the MFA's sound practices in a manner that is consistent with their business models.