The president’s working group on financial markets issued a white paper on “Principles and best Practices for Hedge fund investors” This document supplies a potential investor with best practices in the selection and monitoring of their Hedge fund investments. As forcefully stated in the document “The due diligence process should also include an evaluation of the business infrastructure, investment operations, and controls in place to support your decision”
What to expect from the SEC
Commissioner Luis A. Aguilar of the SEC stated The reason for their (hedge fund) exclusion from regulation is on faulty ground; it seems certain regulation for hedge funds is coming," “Registration may not be enough to give regulators a complete picture. One solution is applying some provisions of the 1940 investment manager’s law to hedge funds”
We're now doing things like canvassing all hedge funds for aberrational performance," SEC enforcement director Robert Khuzami told a House Financial Services subcommittee. He said the focus was on "anybody who is beating market indexes by 3% and doing it on a steady basis."
How the SEC will conduct exams
“We simply show up, because if there are allegations of wrongdoing we don't want to give firms a good deal of lead time to clean up,”
Gene Gohlke, associate director of the SEC's Office of Compliance, Inspections and Examination
“We at the SEC are committed to pulling back the curtain on hedge fund operations and taking a close look at their activity. We are developing a variety of initiatives to do that involving greater specialization and expertise, improved technological tools to track and analyze trading, better coordination among regulators and law enforcement, new legislative initiatives, and other means to address these areas.”
“When we conduct a risk-focused examination, such as of fund advisers to large private equity funds, we will be looking for conflicts of interests, and for evidence that advisers have been vigilant in identifying such potential conflicts and putting in place effective plans or controls to address them.”
Conclusion
Even with looming budget cuts, the SEC will be doing more with less and they will be working smarter than ever before. They have hired individuals who know the capital market and hedge fund businesses. The new methodology that the SEC employs will include a top down approach with an emphasis on an operational and business risk assessment. In this way the SEC can quickly determine whether a hedge fund or private equity fund have a solid governance, internal control framework and reports that will measure those controls. If the SEC determines that these controls are not sufficient to detect major issues, they will then perform a deep dive into the business practices of the hedge fund.