New Era of Transparency Looms for Hedge Funds & Broker Dealers N…

New Era of Transparency Looms for Hedge Funds & Broker Dealers

NEW YORK–LAWFUEL – US Corporate Law, Business Law –The clock is ticking toward a January 24 deadline for bringing hedge fund trading and other practices into compliance with new guidance set forth by the Securities and Exchange Commission in a July 2006 directive.

About to end is the six-month grace period for bringing into compliance soft dollar trading commissions and other practices named in an interpretive release. The SEC is likely to put pressure on prime brokers to ensure that the $1 trillion hedge fund industry complies with its soft dollar rules.

“The soft dollar rules will be a back door method for the SEC to attempt to audit hedge fund activities,” says Richard S. Heller, a partner in the investment management practice at Thompson Hine LLP in New York. “This area of the securities industry has operated in a grey area for more than 20 years. All of that is about to change.”

While hedge funds are no longer required to register with the SEC, new rules that govern how brokers use their commissions are designed to prevent abuses, such as payment for meals, rent, travel and other expenses not directly attributable to investment decisions. The SEC came up with the new compliance guidelines after it found numerous soft dollar abuses when it scrutinized the trading records of a sampling of broker-dealers.

“Prime brokers are easily auditable,” says Heller. “Abuses are going to be more readily discerned if they are the subject of inquiries. Hedge funds are going to have to work with them to make sure that they are in compliance under the new rules. A new era of fund and investment advisor transparency is dawning.”

Section 28(e) covers the use of soft dollar arrangements. The SEC’s new interpretation of this includes a three-step test for determining whether a product or service falls under the safe harbor provision of the rule.

To qualify under the new interpretation, research providers and brokers must first meet the soft dollar eligibility requirements, which include substantive advice, analysis and reports, but not mass market publications (like the Wall Street Journal) or tangible products and services, such as office equipment. Commissions must be reasonable in light of services provided.

“The enormous capital committed to hedge funds continues to grow,” says Heller. “The SEC said that it would not oppose the Goldstein decision, which prevents it from directly regulating funds, but that won’t prevent the commission from exploring other ways to regulate the industry. Putting pressure on broker-dealers is just the beginning. A revised definition of who in fact is an accredited investor is also on the table.”

About Thompson Hine LLP. Established in 1911, Thompson Hine today is among the largest business law firms in the United States. For the last several years, the firm has been named one of the Best Corporate Law Firms in America (in an annual survey of corporate directors conducted by Corporate Board Member magazine). With more than 380 lawyers, Thompson Hine serves premier businesses worldwide, including: Ford, Toyota, Goodrich, Goodyear, Parker Hannifin, Solvay Pharmaceuticals, Eaton, Sherwin-Williams, JoAnn Stores, Verizon and KeyCorp. The firm has offices in Atlanta, Brussels, Cincinnati, Cleveland, Columbus, Dayton, New York, and Washington, D.C. For more information, go to

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