Hedge Funds: A Sensible Approach to Oversight

Antony E. Ghee

Volume 9, Number 3, Third Quarter 2011

After years of debating whether additional regulation should be imposed on hedge funds, legislative initiatives, such as the Dodd-Frank Act, have recently been enacted and could significantly alter the scope of government oversight in an industry that has, until recently, been subject to little regulatory scrutiny. The purpose of this article is not to critique recent legislative initiatives, but rather discuss the historical failings of regulators to detect fraud and other misconduct at early stages. In doing so, this article will also focus on recurring themes that are prevalent in fraud related misconduct, and offer suggestions upon which regulators may improve their efforts to detect fraud before investors suffer significant losses. In 2003, the SEC estimated that as many as 7,000 hedge funds operated in the United States managing approximately $600 to $650 billion in assets. More recent estimates suggest that industry assets peaked around $3.0 trillion just before the credit crisis and global recession began. These figures underscore the point that the industry has experienced a period of exponential growth and simultaneously heightened the concerns of regulators. However, it should be noted that SEC enforcement actions were brought against less than 1% of hedge funds during the past decade. Accordingly, while there has, at times, been investment advisers that engaged in unethical behavior, most hedge fund managers appear to operate with integrity. Thus, the proposals outlined herein are intended to alter the behavior of the unethical while minimizing the impact to industry practitioners that operate with integrity.