US hedge fund managers will be registered as ?investment advisors? with the Securities and Exchange Commission (SEC) from this summer onwards once recommendations in a report on tighter regulation of the industry are implemented.

This was one of the key discussion points yesterday morning during a session entitled ?Recent Developments in Hedge Fund Offerings? at the 15th annual Globalisation of Mutual Funds Conference at the Southampton Princess Hotel.

Cynthia Fornelli, Deputy Director of the SEC?s Division of Investment Management and a speaker on the session panel, oversaw the Commission?s investigation into how the US hedge fund industry operates. She said the review was prompted in part by mutual funds scandals that have rocked the industry and the lack of information the SEC had about the hedge fund market.

?The scandals helped us to re-focus attention on the wider issue of regulating hedge funds from the perspective of investor protection,? she said. ?We looked at it from that perspective because we have seen an explosion in investment in hedge funds in recent years, and much more investment from smaller, retail investors as well as the high net worth investor to whom these funds are usually sold.?

Based on estimates in the report, which was released last September, 6,000 to 7,000 hedge funds operate in the US, managing approximately $600 billion to $650 billion in assets. The report also states that hedge fund assets are predicted to exceed $1 trillion in the next five to ten years.

With more institutional investors such as pension funds, endowments and foundations investing in hedge funds, retail investors are indirectly exposed to the higher than average risks,she said.

?In addition we didn?t know just how big the industry is,? she said. ?Our best estimate is that 40 to 50 percent of hedge fund managers register with the SEC. Some do it because they are required to do so under the current legislation governing investment advisors, some do it voluntarily, but most are not registered with us.?

The result is that most hedge fund advisors have not to date been subject to direct examination and monitoring by the SEC and, although they must comply with the anti-fraud provisions of US securities laws, they remain largely unregulated.

The study and resulting report aimed to address this and other concerns raised about the industry, including: how hedge fund advisors value the assets of hedge funds and the lack of independent review of that process; possible breaches of the rules restricting general (that is, public) solicitation of potential investors when hedge fund advisors use the Internet in communicating with investors; and disclosure issues as regards information provided to investors (on for example multiple layers of management fees in funds of hedge funds), to ensure they are made aware of conflicts of interest their advisor may have.

Another speaker on the panel, David Vaughn, who is a partner at prominent law firm Dechert LLP, also discussed potential conflicts of interest in terms of advisors managing portfolios of registered funds and hedge funds, as well as multiple client accounts, so-called ?side by side management?.

?Legislation to ban this practice was proposed in Congress as a direct response to the mutual fund scandals,? he said. ?If this was to go forward it would of course be a significant change for the managers.?

He said that under the proposal there would be the potential to prevent ?import/export? of investment management services, and that the SEC would have rulemaking authority to permit joint management but only under ?exceptional circumstances?. But according to Ms Fornelli Congress has pulled back on taking this proposal further for now.

?As of now, from our information, Congress is satisfied with the general direction and specific actions the SEC is taking regarding tighter regulatory reforms,? she said.

If the recommendations in the SEC report are adopted in full, which reportedly is what SEC chairman William Donaldson wants, US hedge fund managers and the funds they run will be under an unprecedented level of disclosure and scrutiny.

Currently, managers with fewer than 15 clients under the Investment Advisors Act do not have to register as investment advisors with the SEC.

The managers would also be subject to examination and monitoring by the Commission and required to supply investors and the SEC with disclosure statements so that conflict of interest issues could be identified early.

Ms Fornelli added that non-US advisors would also be required to register with the Commission if they had more than 15 US clients.

?This would probably be the case even if the overseas advisor is registered with the recognised regulator in their own country, such as the Financial Services Authority in the case of UK-based managers,? she said. ?It?s really all about protecting the US investor as far as possible.?

Ms Fornelli later told that the general response among hedge fund managers to the changing regulatory framework had not been negative, particularly against the backdrop of high-profile financial scandals in the markets and the resulting movement for more accountability to investors.

?The managers we contacted during the investigation were very cooperative and open, and they can see the overall benefit of registration in principle,? she said.

?Some might not take that position publicly for either competitive reasons or due to sensitivity among their clients; but overall they say that there is nothing in the proposed registration process that they either can?t do or are not already doing.

?They were obviously concerned about the SEC unduly interfering in how they conduct their business, but we have made it clear we don?t want to impede their progress,? she added. She estimates that there will be 2,000 to 3,000 new registrants under the amended regulations, and says the SEC staff is currently reviewing the organisation to assess resource changes required in order to manage the additional work that will come from the reforms.

Ms Fornelli felt that that there will be further ?retailisation? of hedge funds, which makes the moves to ensure there is better regulation of the industry timely.