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SEC Votes To Increase Net Worth Hurdle for Hedge Fund Investors

cnbc.com
Wednesday, 13 Dec 2006 | 4:58 PM ET

Regulators voted on a proposal that would raise the hurdle investors must meet in order to enter the fast-growing world of hedge funds.

In a 5-0 vote, the Securities and Exchange Commission proposed raising the minimum financial requirements for entry to $2.5 million in net worth, excluding primary residence. Under current rules, an individual must have at least $1 million in net worth or annual income of $200,000 to qualify. The proposal will be open for public comment over the next two months before a final policy is adopted, CNBC's Hampton Pearson reported.

The investor standard for hedge funds - lightly regulated, high-risk investment pools for the ultra-wealthy - has been held at $1 million since 1982. The proposed increase is approximately equal to an inflation adjustment from 24 years ago.

"We want to make sure that we send a strong signal that because ... there isn't the kind of disclosures one would expect with savings and investment vehicles available to retail investors, that caution is in order," SEC Chairman Christopher Cox said in a briefing with reporters aired on CNBC.

The SEC also voted to propose a new anti-fraud rule for hedge funds. The agency was thwarted by a federal appeals court last spring in its effort to bring hedge funds under its supervision. The narrower changes being put forward are not expected to be open to legal challenge.

U.S. hedge funds, now numbering more than 9,000 with assets estimated to exceed $1 trillion, have traditionally catered to the rich, as well as pension funds and university endowments. But they're increasingly luring less wealthy investors.

The funds operate with minimal government supervision. A rise in fraud has hurt Main Street investors: The SEC has brought more than 60 cases charging hedge fund managers with defrauding investors of more than $1 billion since 2001.

SEC to Ease Rules for Businesses

Meanwhile, the SEC proposed new guidance to make it easier for companies to comply with the internal controls section of the 2002 Sarbanes-Oxley law: the commission voted 5-0 at a meeting to propose letting companies take a narrower view on evaluating design and operation of internal controls, or how they keep their books in order.

Section 404 required companies to publicly disclose more information about their controls. It also required companies' auditors to assess the controls and disclose their findings.

As applied over the past three years, Section 404 has been seen as more costly and time-consuming than expected. The SEC's new guidance is meant to encourage an approach to internal controls that is more risk-based and less expensive.

"This proposed approach would enable smaller public companies in particular to scale and tailor their evaluation methods and procedures," Cox said.

The SEC also proposed reducing auditors' burden in the process, recommending cutting a requirement that auditors must sign off on management's procedures for assessing controls. Currently, an auditor must attest to both management's process and the controls' effectiveness.

Commission officials said the guidance is meant to reduce "excessive testing of controls generally; excessive documentation of processes, controls, and testing; and the
ability to scale the evaluation to smaller companies."

The SEC guidance comes as some are blaming 404, in part, for a recent decline in foreign initial public offerings listing on U.S. stock exchanges where they would be subject to 404 requirements.

Short on specifics, the SEC's guidance rests on broad principles, leaving much up to the judgment of individual company executives.

By not completely overhauling the existing 404 rule, the proposed guidance would allow companies that have been complying with the section to carry on with little change.

"Companies that have developed effective procedures over the last three years can continue to follow them," said SEC Corporation Finance Division Director John White.

The SEC's proposed guidance will now undergo a period of public comment, with final action by the SEC coming later.

Further reinterpretation of Section 404 is still to come from the Public Company Accounting Oversight Board, which oversees the audit industry. The PCAOB is expected on Dec. 19 to propose a revised standard for how auditors should handle their reviews of companies' internal controls.

"There was never anything wrong with the principles of 404. What we need to work on is implementation," SEC Commissioner Roel Campos said at the commission meeting.

Both the SEC's and PCAOB's proposals are expected to be subject to heavy lobbying by corporate and investor activist interests during overlapping public comment periods.

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