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New Hedge Fund Rules: Back Door Regulation?

Tuesday, 23 Jan 2007 | 12:53 PM ET

Tomorrow is the deadline for hedge funds and brokers to comply with SEC rules defining the use of soft dollars. The new rules disqualify spending on extravagant incentives such as front row seats at the Super Bowl. In addition, payments for meals, travel, rent and other perks will also be considered abuses. Critics say this is just the SEC's backdoor attempt to regulate hedge funds. On “Morning Call”, CNBC’s Michelle Caruso-Cabrera sifted through the important details.

Here's a bit of background to the rules as explained by Caruso-Cabrera: if you’re a brokerage firm, you make your money from making trades. And the more trades you get, the more money you make. So as a brokerage, you want to court the big hedge funds that do a massive amounts of trades. And you do that by getting them Super Bowl tickets, and flying them all over the world. As of tomorrow, that’s what the SEC is clamping down on.

Janaya Moscony, President of SEC Compliance Consulting, explains that soft dollar rules don't give oversight so much as they give clarification about the use of money. “There’s a distinction that needs to be made between gifts and soft dollars.Two different subjects.”

Hedge Funds & Soft Dollars
The end of hedge funds paying for clients' parties is nigh and some feel it's another way for the SEC to regulate, with James Jalil, Thompson Hine LLP Partner; Janaya Moscony, SEC Compliance Consultants President and CNBC's Maria Caruso Cabrera

Moscony also doesn’t think the new rules will have an enormous impact on hedge funds. “In terms of the regulation of hedge funds, the SEC has always had access to the brokers records… so I don’t see this as anything too new.”

James Jalil, Partner in the investment management practice at Thompson Whine sees the new rules a little differently. He feels this is a back door for the SEC to get in and have some oversight of hedge funds. “It’s true that the SEC has always had the authority to get these records,” he said. “(But) these regulations require that the records be kept directly, the soft dollars be justified, and any allocations be made. So there is more record keeping involved than there has been in the past.”

Jalil can foresee a legal challenge. “We’ve gone down the road of SEC regulation of investment advisors to hedge funds and we all know how that turned out. That was overturned by the courts.”

We’ll have to wait and see.