New York – News that the Galleon Group was being investigated for insider trading is a very significant leading indicator of the hedge fund industry regulation.
Hedge funds have been able to avoid direct scrutiny of the SEC until now, but two things have changed. First, the SEC is still smarting from having bungled the Madoff investigation (or rather the lack there of). As such, the organization is looking to reassert its reputation by taking somebody down. Second, changes instituted by the New Chairwoman, Mary Schapiro, included a greater ability of the SEC staff to take action without the review of the Commissioners. Senior Investigators can now seek subpoenas and instigate investigations without having to seek approval from the Commission. This will speed up the ability of the senior staffers to do their job.
The real question is, is this a game changer at the SEC, or just a face saving exercise? Certainly the SEC has been sullied by the Madoff case and wants to reassert its reputation as the top-cop in the securities industry. But how do we know that they are serious about extending this focus to the hedge fund industry as a whole? The answer is we don’t know for certain.
There is one further reason that may help to institutionalize this new focus on the hedge fund industry. Congress is currently considering financial industry rule changes to attempt to control the reckless behavior of the banking sector. And every congressional reaction goes too far in regulatory stiffening.
One of the recommendations is to have an uber-regulator to manage the securities industry, dark pools, exchanges and derivatives. Just imagine the Frankenstein that would be created under this scenario. Fortunately, we believe that even Congress will not go this far, once they see the complexity of the task.
However, the hedge fund industry will not escape unscathed. Given the regulatory momentum, the current Galleon malfeasance, the new SEC Chairperson and the ability of senior investigators to act without Commission approval, it is very likely that the hedge fund industry is due to be more heavily regulated.
Note: On Monday October 26th, Integrity will post an analysis of the impact of these issues on the research industry.