Hedge Funds – A New Era of Transparency and Openness

Chair Mary Jo White

Managed Funds Association Outlook 2013 Conference, New York, New York

Thank you very much Richard for that kind introduction. I am very happy to be here today and particularly pleased that I could join you at this conference at such an important time in your industry.

The Managed Funds Association has long been an important and constructive voice representing the private fund industry. And that voice is especially relevant today.

I. The Era of Transparency and Openness

Private funds, including hedge funds, play a critical role in capital formation, and are influential participants in the capital markets. And, perhaps more than ever before, the hedge fund industry as a whole is experiencing dynamic change — moving from what some would say was a secretive industry, to a widely-recognized and influential group of investment managers.

Today, I want to focus on this change within your industry, as well as on what the SEC must do as the primary regulator in this space.

There is little doubt that hedge funds have entered a new era of transparency and public openness – a transformation that I believe will benefit investors, the public and regulators. And, one that I believe will ultimately and significantly redound to your benefit as well.

It is a substantial and fairly sudden change brought on as a result of two recent and significant pieces of legislation: the Dodd-Frank Act[1] and the JOBS Act.[2] Although both are designed to promote additional transparency, they do so from different, but complementary perspectives.

The Dodd-Frank Act

The Dodd-Frank Act, as you know, required most advisers to hedge funds and other private funds to register with the SEC, resulting in public reporting of basic information regarding business operations and conflicts of interest.[3] Demonstrating leadership and a commitment to appropriate and effective regulation, the MFA supported this change.[4]

In addition, the Dodd-Frank Act directed the SEC to collect information, on a confidential basis, from private fund advisers regarding the risk-profiles of their funds.[5] And, again, the MFA weighed in constructively, taking the view that confidential reporting to a functional regulator could be beneficial to reducing potential systemic risk[6] – a view that I share.

The JOBS Act

The JOBS Act, meanwhile, facilitates greater transparency and openness in a different way. It directed the SEC to lift the decades-old ban on general solicitation that applied when companies or funds make private securities offerings under Rule 506 of Regulation D – a rule that private funds used to raise over $700 billion[7] in 2012.

As a result, as of September 23, 2013, hedge fund managers feel they have a new freedom to communicate with the public, to advertise, to talk to reporters, to speak at conferences and, most importantly, communicate with investors openly and frankly. And, you can do these things without the fear of securities regulators knocking on your door, or your outside counsel screaming at you.

For some of you, this rule change may not alter your practices significantly. But for others, the new rule will allow communication and engagement with investors in a way not permitted by the old rule.

Taken together, these are significant changes – creating an opportunity for a new era of openness, public engagement and the availability of information about your industry.

As leaders of the private fund community, you are in a unique position to guide your industry through this critical time. And, we – at the SEC – are committed to working alongside you to ensure that this transition is smooth – keeping in mind that your, and our, ultimate focus must be the interests of investors.

I will focus for a few minutes this morning on these changes within your industry and the responsibilities that flow from them. There are new and significant responsibilities that you have, but there are also important responsibilities that we as regulators shoulder in this new era.

I believe it is critical that we work together and each do our part to ensure that this new transparency and openness have a positive impact on capital formation and investor confidence.

Mandated Registration

As recently as 2010, regulators could only see a portion of the financial landscape comprised of hedge fund and other private fund advisers. That is because our view of the market was limited to those advisers who voluntarily registered with the Commission – or were required to do so because, for example, they also managed a mutual fund.

We knew that there was a gap in our knowledge. But, we did not know how many hedge fund managers existed and we did not know who they were -- we could not tell how big this slice of the market really was.

Commentators thought that many advisers would volunteer to register in the belief that an SEC registration would bestow greater credibility in the eyes of investors. And about 2,500 hedge fund and other private fund advisers did step forward. But, we did not know who else was out there.

In the wake of the Dodd-Frank Act, all of that changed. Hedge fund and other private fund advisers, for the first time, were required to become more visible. And, soon we saw over 1,500 new hedge fund and other private fund advisers, bringing the total number of registered advisers to private funds to just over 4,000. Until then, we did not know that we had not accounted for one-third of the industry. Today, as we now know, approximately 40% of the investment advisers, who are registered with the SEC, manage one or more hedge funds or other private funds.[8]

We do not take this new registration development, and what it has revealed, lightly. And we know that it was certainly an important milestone for your industry. It was significant both because of the historically private nature of your industry and because a requirement to register means much more to you than just checking a box on a form and letting us know that you exist.

Registration, as you know very well, requires, as an initial matter, making information about your operations and your funds public.

One immediate benefit of this requirement to your industry should be that transparency will enable you to shed the secretive, “shadowy” reputation that some would say has unfairly surrounded you – a myth that did not serve anyone well, least of all you.

Clearly, the increased transparency and openness creates benefits for you, your investors and the securities markets generally. But it carries with it new responsibilities and obligations as well, for both you as an industry and for us as your regulator. For you, it principally means sharing complete and accurate information with investors and regulators, whether through your registration forms, confidential regulatory reports, solicitation materials, or examination visits. For us, it principally means making sure our rules, examination and enforcement program are accurately tuned to a changing world and foster, not impede, the positive aspects of this growing transparency.

We want to work with you to make sure you are able to live up to your new regulatory responsibilities, but we also hope that you recognize their value. And we need your help when we craft rule proposals that affect your industry or when you find that existing rules are not appropriately calibrated for what you do.

II. The Responsibility of Transparency and Openness

Registration and Disclosure

The most basic regulatory responsibility is providing specific information to your investors and the public – information about the funds you manage, your operations and conflicts of interest. For some of you, providing this information when you registered with the SEC may have been the “first step” into this new era of transparency and openness. But it is familiar and common territory for many other entities across the securities industry.

The registration information you file with us is posted on the SEC’s website, making access for existing and prospective investors easy. In providing this information, you are helping investors understand your business and investment approach – and also helping to inform us by providing data through which we can assess a firm’s business operations, conflicts of interest and leadership.

Our knowledge of the markets and understanding of your businesses is also enhanced when you provide us with non-public data on your funds’ risk profiles, which is required by new Form PF mandated by the Dodd-Frank Act.[9] Form PF provides information on the types of assets you are holding to help to inform government regulators tasked with monitoring systemic risk. Using this information, regulators can then assess trends over time and identify risks as they are emerging, rather than reacting to them after they unfold. As part of this process, it is our responsibility to be sensitive to and safeguard the confidential nature of the data you provide.[10] We take that obligation very seriously.

This era of hedge fund transparency is also new for us. We need to continuously ensure that we – as regulators – are asking for the right information, in the most appropriate way; that we are training our staff to properly understand your business; and that, where necessary, we are hiring the experts who have been in your shoes at one time. We welcome your input on how we might further improve our disclosure and data gathering efforts.

* * *

In addition, the Commission recently proposed a rule[11] that would require you to provide information about offerings you and others conduct under Rule 506 of Regulation D, including those that use general solicitation and advertising.

This proposal is designed, in part, to provide more transparency to enable us to better monitor the private placement market. It would enable us to learn more about the size of the market, those who conduct offerings, and the characteristics of those who are unsuccessful in completing an offering. It also would provide us access to the solicitation materials that are being used and better assure that investors are getting some baseline level of information about risks.

It is part of our effort to ensure that this new market, which private funds dominate,[12] is conducted in a manner that furthers both new capital formation and investors’ interests. We are sincerely interested in your thoughts and constructive input on these topics.

To date, we have received more than 450 comment letters on the proposed amendments,[13] including one we recently received from the MFA. And, recently, we extended the time for the public to comment on the proposal.

This is an important proposal, and there are a lot of different views about it, so it is important to have an opportunity to consider these views. Issues raised in the comment process contribute meaningfully to all of our rulemakings.

But, for investors’ sake and the sake of the new marketplace, we need to move expeditiously toward adoption, following appropriate consideration of the comments. And we must get it right if we are going to make this new era of transparency and openness workable.

Contemporaneously with lifting the ban on general solicitation, the SEC staff has undertaken an interdivisional effort designed to monitor how the ability to advertise and “generally solicit” is actually occurring – how companies and hedge funds are taking advantage of the new rule. It includes assessing the impact of general solicitation on the market for private securities and –importantly –on identifying fraud if it is occurring. If it is, we can seek to stop those in their tracks, who would inappropriately take advantage of this new more open environment.

In a similar vein, because of the SEC’s new “bad actor” rule, which was adopted at the same time the ban on general solicitation was lifted, those who commit securities law violations after the effective date of the new rule (which was September 23, 2013) will be prohibited from participating in this private offering process going forward. There also will be disclosure of past “bad actors” involved in private offerings, to the extent they exist.

We need to keep a very close eye on core investor protection issues as the new “public-oriented” market for private securities initially develops. Our goal is not just to react to investor harm, but also to prevent it.

I think we are all aligned in this effort. We all want this new marketplace to thrive – efficiently, but honestly – for the benefit of entrepreneurs and investors alike.


Of course, the new era of transparency and openness includes more than just registering with the SEC, filing information publicly and communicating more freely with the public.

Registering with the SEC also requires compliance with business conduct rules. These rules are there to help protect investors and safeguard our markets, but they are also rules that should strengthen your operations.

Transparency also means being subject to an occasional visit by a team of our professional compliance examiners – who will review your records and sit with you to evaluate whether your firm is being run in compliance with these business conduct rules and other requirements.

This may not be the most welcome aspect of the new age of transparency for hedge fund advisers. But it is a very important component of our regulatory work because well-conceived rules are of little value if they are not being followed. So, our examinations are designed to evaluate compliance, but also to assist you as you work to achieve your compliance objectives.

Since registering with the SEC, some of you may already have received your first visit from an SEC examination team. And, hopefully, you found them to be informed, professional and constructive. Certainly, that is something you deserve and should expect. And something we continuously seek to foster in our teams.

Now, I know questions have been raised about whether inclusion of private fund advisers in our examination program makes sense, given the often sophisticated nature of hedge fund investors. The question is legitimate and, as the head of a regulatory agency, I need to continuously assess whether our resources are being deployed in the most productive, cost-effective manner.

That being said, the SEC has a mission of investor protection that runs across the investor landscape. It applies to all investors, and all investors in the U.S. markets deserve to know that there is a regulator on the block, looking around corners and concerned about their interests.

We should also recognize that, while many hedge fund investors are considered to be “sophisticated” or “institutional,” those terms apply to a wide swath of investor types. And the investment performance of institutional investors can affect the lives of people on the street. Institutional investors, for example, include pensions funding workers’ benefits, college endowments and charities. These “sophisticated investors” can and do have a real impact on main street investors.

So, yes, our examiners are in your space. We are, however, trying to be “smart” about how we examine.

That is why we launched an initiative to conduct focused exams of newly registered advisers. These examinations, known as “presence exams,” establish our regulatory presence with registered private fund advisers in a very tangible way. Our examiners are on-the-ground, in-person, discussing issues of importance to hedge fund advisers and their investors.

These presence exams, which are shorter in duration and more streamlined than typical examinations, are designed both to engage with newly-registered hedge fund and other private fund advisers and to permit our examination team to examine a higher percentage of new registrants.

The goal of the examinations is not to play “gotcha.” It is instead to make sure newly-registered private fund advisers are aware of their obligations under the SEC’s rules. And it is to promote investor-oriented business practices through, among other things, the sharing of best practices.

To foster a two-way street of transparency, we are making known the areas that are of interest to us. For instance, in a letter we sent to senior leadership of newly-registered private fund advisers, we explained that the staff is pursuing five focus areas for the presence exams:

  • marketing;
  • portfolio management;
  • conflicts of interest;
  • safety of client assets; and
  • valuation.[14]

We will work cooperatively with you to address any irregularities. But, should we find fraud, we will pursue it, just as you, your investors, and your fellow market participants would expect us to do.

III. The Regulator’s Responsibilities

Making Sure our Rules Work

Just as you have many new responsibilities, we too have additional obligations.

For instance, at the SEC, we need to fully understand your business and take into account the private fund business model and the needs of private fund investors. And, we have been striving to do that.

In August, for example, the SEC staff put out guidance[15] on how our custody rule[16] should apply to private stock certificates. That rule seeks to protect investors by imposing certain requirements on those private funds that hold stock certificates that represent the underlying ownership interests of the fund.

Through our engagement with the industry, however, the staff recognized that applying the custody rule in the private fund, and particularly, the private equity fund context may not work as intended.

In particular, the staff noted that existing mechanisms, such as the financial statement audit, provided appropriate investor protections and maintenance of stock certificates with a separate custodian often resulted in additional costs to investors and firms, with little added benefit. So, our staff advised that maintenance of private company, non-transferable stock certificates with a custodian is not necessary if the private fund is audited as required by the custody rule.[17]

Although I understand that we may need to take further steps, the staff guidance on the custody rule exemplifies our efforts to tailor the application of SEC rules to hedge funds and other private funds, while at the same time promoting meaningful investor protection.

As with the custody rule, we are also regularly considering our rules related to advertising – an area that is front and center in light of the JOBS Act and the new freedom that hedge fund advisers have to advertise. Even before the JOBS Act, hedge fund advisers had questioned SEC rules prohibiting testimonials and the meaning of the ban on “past specific recommendations.”[18]

And, I can imagine we will receive additional questions regarding the effectiveness of our advertising rules as hedge funds begin to “generally solicit” under the new rules implementing the JOBS Act.

From my perspective, I want to know if we are targeting the right areas, and if our rules, written decades ago, are still relevant and effective today.

Should, for example, the SEC or some other organization attempt to mandate standardized performance disclosure for hedge funds consistent with a recommendation from our Investor Advisory Committee?[19]

These are just some of the questions we are asking at the SEC and, for our rules to work right, we need your input.

A Focused Enforcement Program

Finally, because of the greater transparency, the SEC will have a clearer picture of the players and practices in your industry – including those who engage in fraud or sharp practices. This clearer picture gives us a window into the whole industry and enables us to craft an enforcement program that is more focused and directed.

Recently, the SEC has been quite active in bringing enforcement cases involving private funds. These cases have involved charges related to: insider trading; false advertising and performance claims; overvaluing assets in order to charge excessive fees; benefitting favored investors at the expense of other investors; and using private fund assets for the personal benefit of the fund’s adviser.

The existence of bad actors and outright fraudsters in the private fund industry hurts investors and obviously damages the industry’s reputation. None of us should stand for it.

It is essential, on our part, that the SEC have strong and vigilant examination and enforcement programs to root out these bad actors in order to build investor confidence in the fairness and integrity of our markets. It is important to you as an industry that we succeed in these efforts. And we welcome your support.

IV. Conclusion

Going forward in this new era of transparency and regulatory oversight, we want to work with you because we both shoulder new and important responsibilities. We know you will take these new requirements seriously and we do too.

We want to hear about the tools we use to gather information. And we want to hear about our efforts to stay current on your industry. We welcome your input on our regulatory effectiveness.

We also want to hear how our rules, examination and enforcement focus can be better targeted to the needs of private fund investors.

As hedge fund leaders, you have close relationships with your investors. You communicate with them regularly. You understand their needs. We need for you to share their perspectives with us.

My bottom line: we look forward to continuing to work with you constructively in this new era of transparency. If we do, our markets will be strengthened, investors will be protected, and your businesses can operate from a more transparent and stronger platform.

Thank you.

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[1] Pub. L. No. 111-203, 124 Stat. 1376 (2010).

[2] Pub. L. No. 112-106, 126 Stat. 306 (2012).

[3] Section 403 of the Dodd-Frank Act (codified at Section 203(b) of the Investment Advisers Act of 1940, as amended).

[4] Testimony of Richard H. Baker, President and Chief Executive Officer, Managed Funds Association, for the Hearing on Capital Markets Regulatory Reform: Strengthening Investor Protection, Enhancing Oversight of Private Pools of Capital, and Creating a National Insurance Office, before the Committee on Financial Services, U.S. House of Representatives (October 6, 2009)., available at


[5] Section 404 of the Dodd-Frank Act (codified at Section 204(b) of the Investment Advisers Act of 1940, as amended).

[6] Testimony of Richard H. Baker, President and Chief Executive Officer, Managed Funds Association, for the Hearing on Systemic Regulation, Prudential Matters, Resolution Authority and Securitization, before the Committee on Financial Services, U.S. House of Representatives (October 29, 2009), available at



[7] Vladimir Ivanov and Scott Bauguess, Capital Raising in the U.S.: An Analysis of Unregistered Offerings Using the Regulation D Exemption, 2009-2012 (July 2013), available at:, Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings, Advisers Act Release No. 3624 (Jul. 10, 2013) [78 FR 44771 (Jul. 24, 2013)], available at

[8] “ Dodd-Frank Act Changes to Investment Adviser Registration Requirements,” available at

[9] Reporting by Investment Advisers to Private Funds and Certain Commodity Pool Operators and Commodity Trading Advisors on Form PF, Investment Advisers Act Release No. 3308 (October 31, 2011), 76 FR 71128 (November 16, 2011), available at

[10] Reporting by Investment Advisers to Private Funds and Certain Commodity Pool Operators and Commodity Trading Advisors on Form PF, Investment Advisers Act Release No. 3308, at Section II.D, “Confidentiality of Form PF Data” (October 31, 2011), 76 FR 71128 (November 16, 2011), available at

[11] Amendments to Regulation D, Form D and Rule 156, Securities Act Release No. 9416 (Jul. 10, 2013) [78 FR 44806 (Jul. 24, 2013)], available at

[12] See Vladimir Ivanov and Scott Bauguess, Capital Raising in the U.S.: An Analysis of Unregistered Offerings Using the Regulation D Exemption, 2009-2012 (July 2013), available at:, Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings, Advisers Act Release No. 3624 (Jul. 10, 2013) [78 FR 44771 (Jul. 24, 2013)], available at

[13] Comments are available at “Comments on Proposed Rule: Amendments to Regulation D, Form D and Rule 156 under the Securities Act,”

[14] See “Letter Regarding Presence Examinations,” available at

[15] “IM Guidance Update: Custody of Privately Offered Securities,” (August 2013), available at

[16] 17 CFR 275.206(4)-2.

[17] “IM Guidance Update: Custody of Privately Offered Securities,” (August 2013), available at

[18] 17 CFR 275.206(4)-1(a)(1) and (2).

[19] Recommendations of the Investor Advisory Committee Regarding SEC Rulemaking to Lift the Ban on General Solicitation and Advertising in Rule 506 Offerings: Efficiently Balancing Investor Protection, Capital Formation and Market Integrity (January 2013), available at


Last Reviewed or Updated: Oct. 18, 2013