February 1, 2007
I am a CPA with 30 years experience. I am also a principal with Inline Capital Management, LLC, (ICM) a registered investment advisor in Texas. At ICM, I am responsible for compliance and administration.
First, the SEC does not need to raise the dollar requirements for hedge fund investors. There are people with lots of money that are flat ignorant when it comes to investments. Instead, the SEC can require investors in hedge funds to be represented by a registered investment advisor that is independent and unrelated to the hedge fund. These advisors can help the investors decide if a particular hedge fund makes sense for them. The SEC can regulate these independent advisors to make sure they are qualified for this task and follow certain procedures.
Second, the SEC needs to require all hedge funds to use a custodian and third party administrator, and to have an independent annual financial and performance audit. These will help take away the possibility of the hedge fund managers stealing the money and then covering it up when they report to their investors. The custodian and third party administrator can control the money flows in and out of the hedge funds. They can in essence be gatekeepers and record keepers. The annual audit will take care of the reporting to investors. The SEC can regulate the custodians, third-party administrators and auditors to ensure they meet certain standards and follow certain procedures.
Finally, the SEC should not allow hedge funds to advertise. Like the mutual fund and financial planning industry, the big money firms with large advertising budgets and their feel good advertising will dominate the hedge fund industry. This will lead to mediocrity and an uneven playing field. Let the returns speak for themselves. Give everyone a chance to compete.
Higher dollar requirements for hedge fund investors will not solve the biggest problem facing the industry, fraud. The SEC cannot regulate away losses. Losses are an integral part of capitalism in that they repel capital. The hedge funds should be allowed to be free and creative in their search for profits. If the SEC follows the suggestions in this commentary, the free market will weed out the inferior hedge funds and the bad apples. The hedge fund industry will flourish and investors will be sufficiently protected and make more money. Moreover, Adam Smith's invisible hand will work its magic.