August 7, 2004
We believe that the proposed registration rules will be extremely burdensome for the small hedge funds. For the hedge funds with less than ten million in capital, the 1 percent asset management fee is inadequate to cover all of the increased costs associated with staying in compliance with the Investment Adviser regulations. For the small hedge fund firms, with one or two employees, the new regulations will require the employees to devote substantial time away from research and trading, and focus instead on rules, regulations, and compliance.
As it stands currently, we believe that the investment community, as represented by major Wall Street financial firms such as banks, brokerage firms, financial conglomerates, and large hedge funds, have cut back on their research and trading of small and mid capitalization equity securities. Over the past ten years, due to the increased cost of regulations and the structural changes in the market making world, many small NASD member firms have closed or merged. It is our belief, not based upon statistics, but based upon experience and perception, that many of the market research functions of the small NASD members have migrated to the small hedge funds. The research on small capitalization securities, which was once done by small NASD members, is now being done by small hedge funds. These research oriented hedge funds are not the fund of funds that are open to investors on a monthly basis. They are run by individuals who are
dissatisfied with the established research structures of the financial community. Due to the economics of size, large financial conglomerates can not get involved in small and microcap equities.
We believe that the existing proposal by the commission should be modified in some form to take into account the smaller hedge funds, with less than 25 million in capital, and who have less than 25 investors and who specifically do not solicit capital from funds of funds. The Commission, by throwing the same regulatory blanket over all hedge funds, will place the smallest funds at a substantial competitive disadvantage. In a one or two person firm, with 10 million under management, the annual cost of compliance could easily fall between 25,000 and 50,000, which represents twenty five to fifty percent of the firms asset management fee. We would recommend that the Commission consider establishing a modified regulatory structure for smaller hedge funds.
Of tantamount importance to the Commission is the need to prevent fraud amongst hedge funds.Thus perhaps the Commission could impose a law requiring all funds not registered with the Commission, and which have less than 25 million, but with investors numbering over 15 but up to 50, file with the Commission annual audited financial statements. The requirement of an annual audit would be less burdensome than the requirements under the current proposal, but would still satisfy the basic goals of the Commission.