Law for the fraud examiner

Hedge fund fraud: Curbing the growth

By Juliana Morehead, J.D., CFE
Fraud & The Law

In December 2004, the Securities and Exchange Commission (SEC) published a final rule and amendments to the Investment Advisers Act of 1940 ("Act").1 The ruling required certain hedge fund advisers to register with the SEC by Feb. 1, 2006. Here we'll discuss this ruling and issues related to provide the fraud examiner an overview of the new law surrounding hedge fund fraud and attempts to curb it.

Although there's no statutory or regulatory definition of "hedge fund," the term typically refers to private pooled investment vehicles managed by advisers who generally have a very large financial interest in the funds based on a management fee that includes a percentage of the fund's performance. Hedge funds employ various speculative and aggressive strategies that aren't commonly available to mutual funds. They often combine traditional investments with short sales, leveraging, and arbitrage strategies to maximize returns.

In the past few years, the U.S. securities market has seen a significant growth in the number and size of hedge funds. According to various studies, more than 8,000 hedge funds make up a $1 trillion industry.2 This is a massive jump from the $38 billion hedge fund industry in 1990.3 Consequently, hedge fund fraud has grown substantially enough for the SEC to take extraordinary measures to regulate it. Between 2000 and 2004, the SEC brought 51 cases against hedge fund advisers for defrauding hedge fund investors or using the funds to defraud others.4 In 2005, the SEC brought 11 hedge fund fraud cases and has several investigations underway.5 

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