Hedge funds: The regulatory landscape at a crossroads

Hedge funds increasingly are becoming a focus of investors and U.S. regulatory agencies including the U.S. Securities and Exchange Commission (the “SEC”), the U.S. Treasury Department, the National Association of Securities Dealers, and the Commodity Futures Trading Commission as enhanced regulatory attention is forcing the hedge fund industry for the first time since the near‐collapse of Long‐Term Capital Management, L.P. in late 1998 to examine itself more closely. In light of the dismal performance of U.S. stock market indices over the past several years, investors are turning to “absolute” return vehicles, such as hedge funds, that are able to generate current positive returns in a market that has returned consistently laggard results. Investors’ ability to invest in hedge funds has been further enhanced by the increase of hedge funds‐of‐funds registered under the U.S. Investment Company Act of 1940, as amended (the “1940 Act”). Simultaneously, over the past 18 months, the SEC has become increasingly concerned with a multitude of industry occurrences including (i) the widening access of investors to hedge funds, (ii) the unregulated nature of hedge funds, potentially leading to fraud or conflicts of interest with their investors, and (iii) the impact of hedge funds on the markets, especially in relation to their use of short selling. As U.S. regulatory attention remains focused on the hedge fund industry and industry practice and the themes of potential new regulations become apparent, it has become a cautionary period for hedge fund sponsors and investment managers.