The issue of regulation and transparency

Regulation, regulation and more regulation seems to be the apparent answer to global financial woes, at least in the eyes of the US government. The issue was examined in detail as it relates to the investment funds industry at the Campbells Fund Focus. Business Editor, Lindsey Turnbull reports.

According to Harry Davis, attorney with US firm Schulte Roth & Zabel, the post-Madoff analysis by the US government of what went wrong heaped strong criticism on the US regulator, the Securities and Exchange Commission.

“Of course, this is not the first time the SEC had been criticised, but it has certainly been the harshest,” he said, and he went on to highlight some of the issues where the SEC was thought to have been lacking, including a failure to conduct thorough and competent examinations of funds and their managers as well as a failure all round by their inspectors to recognise worrying red flags.

“Complaints ranged from inadequate communication, to inadequate third party verification to the SEC inspectors not being sceptical enough when Madoff gave them answers,” Davis said, as he moderated a panel analysing international and local regulatory pushes on investment funds as well as the issue of transparency.

Thus, according to Davis, the funds industry and the SEC were currently caught in the cross hairs, with the resulting impact on the industry of SEC examinations made more difficult and undertaken by “career prosecutors” now employed by the SEC, as well as a slew of regulatory pushes such as the Investor Protection Act and the Hedge Fund Transparency Act all winding their way to Washington.

On the flip side, Davis pointed out that Washington was already rather busy at the moment dealing with issues such as healthcare reform, Iran’s nuclear capabilities and the wars in Iraq and Afghanistan.

“Thus, there is a commitment to get these acts passed as law, but I am less confident about the ability to predict when this will happen,” he said. 
One piece of law that Davis calls a “foregone conclusion” is the oncoming requirement for all US-based hedge fund managers to be registered by the SEC (as opposed to the registration of the fund itself).

Davis was sceptical as to what the SEC would actually be able to do with all this new information and doubted whether it would actually prevent a fraud from taking place.

“I believe this industry is pretty clean on the whole and I don’t believe the SEC examination process will find anything,” he said.

Davis envisaged more investigation by the SEC as to preferential redemption processes, side letter arrangements and the possibility of any insider trading taking place. He also believes that they would attempt to regulate the derivatives market and possibly put the credit default swap market onto an exchange.
Davis thought it unlikely though that the SEC would turn into some sort of ‘super regulator’.

Keith Miller attorney with US firm Paul, Hastings, Janofsky & Walker sat on the panel and said that Madoff was indeed a wake-up call for the SEC.

“It’s no longer business as usual,” he confirmed, echoing the moderator’s views. “Madoff has sharpened the focus on Ponzi schemes and the SEC has now become much more active and taken a much more aggressive stance.”

Miller detailed how the SEC has broken itself down into five specific target groups that they believe can deal with specific issues facing the industry, including a group devoted to the examination of asset management. This group, Miller said, was relevant to Cayman as it focuses on advisors to hedge funds. Other groups include the market abuse unit and the structures and new products units.

He also said that the SEC was attempting a better approach to the industry, with a desire to work more closely with the industry in an attempt to exchange information rather than simply just receive it.

Lessons learned from Madoff have caused the SEC to look at better training for its employees, in such areas as forensic technologies and Ponzi schemes which he says, “will help to reform staff and their expertise”.

 

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From left, Harry Davis, Keith Miller and Yolanda McCoy

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