From: David Friedland
Sent: February 22, 2007
Subject: File No. S7-25-06

Below please find the comments regarding Proposed Rules 509 and 216 submitted on behalf of the Hedge Fund Association, a not-for profit association representing hedge fund managers, hedge fund investors and service providers:

  1. The definition of investment vehicles exempt under 3(c)1 covers a very broad spectrum of investment strategies and hedge funds. In particular, the definition would include funds of hedge funds, which are by design less risky than an investment in a single hedge fund, and significantly less risky than an investment in a stock mutual fund, or portfolio of stocks. The majority of funds exempt under 3(c)1 are smaller, emerging hedge funds, and funds of hedge funds. These funds often have minimum investments of $100,000 or $250,000. The new proposed rule would significantly reduce the number of potential investors for many funds of funds. This would possibly have the effect of having existing funds of funds close down, and preventing new funds of funds from entering the industry. This would have the effect of reducing the number of funds of funds in the industry. Funds of funds play a number of very important roles in the industry:

    1. they allow investors to invest in hedge funds in a low risk manner. Investors can rely on the experience and expertise of the fund of funds manager, and get the benefit of purchasing a diversified fund. Without funds of funds, investors would look to invest in hedge funds directly, and although such investor may well meet the new accredited natural person standard, such approach may well be more risky for that investor than relying on a fund of funds manager who has experience, knowledge and the resources to adequately perform due diligence and build a diversified portfolio

    2. funds of funds act as a de facto regulator for hedge funds. Hedge funds have to act in a certain manner if they wish to attract capital from professional investors. That would apply to issues like transparency, equal treatment of investors, provision of audited statements etc.

  2. The proposed definition of accredited natural person would not have an impact on the larger hedge funds, as they are likely excluded under 3(c)7. It would however have an impact on smaller hedge funds. The new rule, as opposed to increasing competition amongst 3(c)1 funds because of fewer investors, would more likely result in 3(c)1 funds closing down because of lack of investors, or force such hedge funds to open up exclusively 3(c)7 funds. This new rule would also likely be an impediment to new hedge funds entering the industry. Most new hedge funds build their businesses with friends and family capital and to the extent those investors do not meet the new standard, where would a new hedge fund manager go to for start up capital? The result would be a reduced number of 3(c)1 funds in the industry, which will have the opposite effect. We may see higher fees, not lower fees, and we may just see hedge funds not offering 3(c)1 funds any longer, relying solely on the 3(c)7 exemption. If that happens, you would essentially be preventing any investor with less than $5 million of investments from being able to invest in hedge funds.

  3. Although you state that funds are far more sophisticated and complicated today, with the advent of the internet, information is far more freely available than it was 20 years ago. Therefore, although hedge funds may well be more sophisticated and complicated, getting information on hedge funds, doing research on someone and finding out more information about a specific hedge fund has never been easier. As a result, as opposed to looking at the past 20 years as a reason to make hedge funds less freely available, given their performance compared to the stock market, the amount of freely available information, and the professional manner in which hedge funds are now managed should be reason if anything to broaden the scope of hedge funds, not lessen the scope.

  4. These proposed rules discriminate against the smaller hedge funds and against funds of funds, who have as their primary target investors who meet the old standard but who fail to qualify for the 3(c)7 definition. Furthermore, the rule discriminates against the investing public, by telling an investor who may well have been investing in hedge funds for the past 15 years, but who no longer qualifies, that he/she can no longer invest in hedge funds, because as far as the SEC is concerned, such investor is not able to determine the risks of hedge funds. Furthermore, such investors, who no longer are able to invest in hedge funds and funds of funds will now only be able to invest in stocks or equity mutual funds to make the returns they have been accustomed to making. The problem with that is that hedge funds and funds of hedge funds have over the past 20 years, despite the well publicized blow-ups, been significantly less volatile and less risky than any stock investment or equity mutual fund investment. In fact, studies have shown that all the capital lost in every hedge fund blow-up was less than the capital lost in Enron alone. The effect of this rule amendment will drive investors to invest in riskier investments like stocks and equity mutual funds, and will not even allow an investor who has had personal experience of investing in hedge funds to invest in the future.

  5. The proposed rule makes it less likely for foreign fund managers to open up domestic funds for US investors to invest in, given the more stringent eligibility rules. As a result, such foreign fund managers would be more likely to focus their efforts on foreign markets, making fewer funds available in the US, even for the most sophisticated and wealthy investors.

This proposal clearly has a negative impact on investors and hedge funds alike. As opposed to fostering competition, these rules will have the opposite effect. However, if you are still convinced that the definit6ion of accredited natural person needs to be changed, we have provided a few suggestions for the proposed amendment:

  1. Funds of funds should be categorized differently than single hedge funds, due to the conservative nature, and appropriateness of such investments for all investors. Funds of funds should be more widely available, not more restrictive.

  2. As for single hedge funds, if you are absolutely convinced hedge funds need to be made less available to investors, you should either remove the value of one’s primary residence from the equation and leave the net worth test at $1million, or keep the value of one’s primary residence in the equation and increase the level to $2 million (which is based on the inflation figures you presented). Certainly the value of homes have appreciated enormously over the past 20 years, and if someone met the old test purely because of their home, perhaps they should not be considered sophisticated or wealthy. However, if someone has a home worth $4 million and has $2 million of hedge fund investments that he/she have owned for the past 15 years, how can you possibly say that such a person is not accredited or qualified to evaluate the risk of hedge funds?

  3. If an investor is a current investor in a hedge fund, such investor should be grandfathered in to all future hedge fund investments. To not do so would be completely illogical.

As for the first part of the rule, in terms of extending the anti-fraud provisions of the Act, we would be in favor of such amendments. We are an association that represents hedge fund managers, hedge fund investors and service providers. Therefore, we look out for the interests of all facets of the industry. The anti-fraud provision amendments protect investors and we are therefore in favor of such amendments. However, we believe that the new rule regarding the definition of an accredited natural person is detrimental to investors and hedge fund managers alike and we are therefore highly opposed to the proposed amendment.


David Friedland
President, Hedge Fund Association