Rules for a Hedge Fund

Original post by Geri Terzo of Demand Media

Hedge fund regulation increased after the financial crisis of 2008.

Comstock/Comstock/Getty Images

Hedge funds have historically been subject to less regulation than traditional investment funds. This began to change in the aftermath of the 2008 financial crisis when investors lost large amounts of money to market declines and investment scams. New laws and standards have been enacted that apply to hedge funds, although they're still less regulated than other conventional funds. Hedge fund rules are continuing to evolve, but some clear standards have been adopted for how these investment managers must operate.

SEC

In 2011, U.S. regulators adopted rules that require hedge funds with at least $150 million under management to register with the U.S. Securities and Exchange Commission. Greater involvement by attorneys and risk officers in hedge fund activity is also required, according to an article published on the CNBC website, "The SEC's New Hedge Fund Rules." The article questions the positive impacts on increased hedge fund regulation.

Short Selling

Short selling is a common trading strategy in the hedge fund community. It is a speculative strategy that involves an expectation that a stock's price will drop. During the summer of 2011, several European countries adopted a temporary ban on short selling, prompted by erratic trading in the financial markets. U.S. regulators were reportedly considering a similar ban, although it was tried during the 2008 financial crisis and did not have the calming effect desired.

Investors

Many of the rules that now apply to the hedge fund industry are designed to protect investors. One rule adopted by the SEC in 2011 tightens the criteria for wealthy investors wishing to invest in hedge funds. Under the new guidelines, prospective hedge fund investors must have a net worth of at least $2 million, excluding the value of a residence.

Leverage

Leverage is the amount of debt, or borrowed shares, that hedge funds accrue in the hope of magnifying profits. If a fund manager outlines leverage limits in fund documents, he must adhere to those investment standards or he may be subject to litigation. In 2010, hedge fund manager Mark D. Lay of MDL Capital Management was found guilty of fraud for deceiving investors and exceeding leverage limits stated in fund documents, according to an article on the Compliance Building website.

Resources

• The Hedge Fund Journal; Short Sale Restrictions Imposed in EU; August 2011
• Securities and Exchange Commission: SEC Charges Mark D. Lay and MDL Capital Management, Inc.
• The New York Times; For Small Hedge Funds, Success Brings New Headaches; Azam Ahmed; January 2011

References

• CNBC; The SEC's New Hedge Fund Rules; John Carney; June 2011
• "The New York Times"; Four European Nations to Curtail Short-Selling; Louise Story, et al; August 2011
• Compliance Building; Fund Manager Fraud for Exceeding Leverage Limits; July 2010
• Forbes; SEC to Raise Threshold For Hedge Fund And Private Equity Fund Investments; Timothy Spangler; May 2011

About the Author

Geri Terzo is a business writer with over 15 years experience reporting on Wall Street. Her coverage ranges from institutional investing, including hedge funds and investment banking, to family topics and her career experience includes work for Fox Business, CNBC and "IDD Magazine." Terzo is a graduate of Campbell University, where she earned a B.A. in mass communication.

Photo Credits

• Comstock/Comstock/Getty Images