Hedge funds snub SEC e-mail archiving rule

By Beth Pariseau, News Writer
SearchStorage.com
January 31, 2006

Hedge fund managers have until Feb. 1 to register with the Securities and Exchange Commission (SEC) according to an Oct. 2004 compliance ruling, but industry experts say only a minority of the financial firms are pursuing e-mail archiving and other records retention policies -- and that this week's deadline may prove to be just the first battleground in bringing hedge funds under the control of the SEC. The ruling, passed in October 2004 as an adjunct to the Investment Advisers Act of 1940, was intended to address the SEC's contention that hedge funds have gone in recent years from being the off-shore, high-risk playground of the extremely rich to a more common area for less experienced investors to play in...

...Specifically the ruling states: "All records (as so defined) of such investment advisers are subject at any time, or from time to time, to such reasonable periodic, special, or other examinations by representatives of the Commission as the Commission deems necessary or appropriate in the public interest or for the protection of investors." (Translated, hedge funds need to keep all e-mail and produce it in a timely manner.) Though most hedge funds remain anonymous to the SEC in the days before the deadline, some are registering with the SEC as requested; a few have even been voluntarily registered for years...

"No one wants to run a fund the wrong way, but part of the reason they are so successful is because they can run without so much regulation," said a source at a company that manages hedge funds, who requested anonymity. The regulation requires that hedge fund managers register as investment advisers with the SEC using "Form ADV," which calls for information including how many funds they manage, the amount of assets in the fund, their number of employees and what other types of clients they serve. Once the SEC knows who they are, it can begin auditing the firms, which so far have enjoyed relative obscurity...

..."[Hedge funds] are subject to regulations like every other financial entity," said Greg Nowak, a securities lawyer and partner in the Philadelphia office of Pepper Hamilton LLP, who specializes in representing investment management companies and other clients on matters relating to the Investment Advisers Act of 1940. "But right now they're only subject to 'after-the-fact' regulations, not the proactive regulations the SEC is proposing." Another part of the fight, Nowak added, was that the SEC has made harsh pronouncements about cracking down on hedge funds, but hasn't specified how exactly compliance can be achieved.

"They've told hedge funds they have to retain e-mails and IMs," Nowak said. "But they haven't told us what they'll be looking for, and in what format." Nowak predicted that in the short term, most hedge funds would escape the regulation through what's referred to as "the two-year loophole," a clause in the rule excluding funds which lock investors in for two years or more. The original intention of this part of the rule was to distinguish between private equities funds and hedge funds, but financial experts say it has had far from the intended effect -- of the 8,400 or so hedge funds in the U.S., only an estimated 1,000 to 1,500 were expected to fall under the SEC's rule as currently written. Of those, only 700 to 800 were expected to make the registration deadline of Feb. 1...

...Cost and staffing are not the only issues preventing hedge funds from meeting the deadline. In fact, as of this week, many of the funds were still fighting to overturn the ruling rather than working to comply with it. Opponents to the rule argue they are already heavily regulated, and have suggested that the SEC follow hedge funds using the documents they are already required to file. A lawsuit along these lines filed against the SEC by hedge fund advisers Phillip Goldstein and Opportunity Partners is still pending...

...Of an estimated 8,400 hedge funds in the U.S., LiveOffice said yesterday that about 75 are using its AdvisorMail product, by far the largest number of users among the companies SearchStorage.com surveyed. Symantec Corp. said that about 30 direct hedge fund customers are using its Veritas Enterprise Vault archiving software and another 20 outsourced customers through partner FivePoints Compliance Inc. Another outsourcing firm, IPR International LLC, reported five hedge funds for its e-mail archiving service...