In a post on Bloomberg today, the SEC is reported to have "dozens of active investigations" related to hedge funds.
The specific topic of the Bloomberg story is the potential for hedge funds to give their own principals and management, together with favored investors, beneficial treatment when imposing redemption restrictions. The risk is that funds may have let themselves - and their best clients - get to the exit first, particularly during Q4 2008 when many imposed gates, suspended redemptions or otherwise restricted investors' ability to access their capital.
An interlinked topic here is likely to be the use of side letters, which is a much broader topic best saved for another post. The whole issue, however, of whether it is fair to let some investors get out quicker than others based on a side deal was always likely to come to a head at some point.
Side letters were a topic of concern a couple of years ago, with the main outcome that funds were advised to improve disclosures. However, in a classic example of prospectus creep, the friendly hedge fund attornies responded by adding new disclaimer language in many fund offering documents which simply allowed managers to issue side letters amending absolutely any term in the prospectus. Against this background, what also needs to come to a head is the broader topic of whether risk disclosures in fund offering documents. Caveat emptor is a fine principle, but unfortunately becomes a mockery when offering documents have been drafted to allow flexibility for pretty much anything "in the sole discretion of the investment manager".
There is also a related question as to whether many side letters related to offshore funds are even enforceable. This is particularly the case for US managers who signed them themselves, completely ignoring the fact that offshore funds are corporate entities with - supposedly - a Board of Directors responsible for corporate governance.
As an aside, both the topic of fund offering documents as well as the need for better corporate governance were discussed in Castle Hall's White Paper, "Hedge Fund Investing in a New World." The paper is available here for interested readers.
Bloomberg also gives a laundry list of other hedge fund sins under the SEC microscope:
- whether feeder funds who direct money to other organizations completed the due diligence they promised to their clients (Madoff, Petters etc.);
- improper valuation of illiquid assets;
- manipulation of securities prices;
- insider trading, including in the markets for credit derivatives.
Add to these topics yesterday's investigation of ex-executives at the New York State Common Retirement Fund who allegedly took kickbacks from investee funds, and it seems as if the regulators have a wide range of rocks to look under.
Hedge Fund Operational Due Diligence
Great post as always. Nothing more to say.
Posted by: Bart Mallon | March 21, 2009 at 12:07 AM