Hedge funds planning for increased compliance costs: report

Nearly one-half of hedge funds surveyed expect their compliance costs to increase over the next 12 months, according to a recent study by Greenwich Associates.

These expectations come on the heels sizable expenses associated with registering with the U.S. Securities and Exchange Commission incurred by hedge funds in 2005.

“The expectation of rising costs indicates that hedge fund managers as a whole recognize that, for better or worse, hedge funds are entering into a new era of regulation, and checking the box for registration might prove to be the easiest part,” says Greenwich Associates hedge fund specialist Karan Sampson.

Greenwich Associates surveyed 34 compliance officers at prominent hedge funds operating in the United States and Europe. Slightly more than half of the participating funds had already registered with the SEC at the time of the study, and almost all the funds said their costs for regulatory compliance had increased in 2005. The compliance officers surveyed cited several serious concerns, the firm reports, including: creating effective record-keeping systems and practices, particularly for e-mail retention; monitoring and enforcing rules regarding personal trading by fund employees; and, getting support from senior management for compliance-related efforts.

“There is a real question in the minds of many chief compliance officers about whether the independent-minded partners of hedge funds will fully listen to a CCO,” says Greenwich Associates consultant William Wechsler. “This could pose a significant risk to hedge funds facing the increased compliance burden associated with registration. On the other hand, there is also the possibility that the dictates of SEC registration might grant new clout to CCOs within their own organizations.”

Greenwich suggests that once the new rules go into effect, the credibility gained through SEC registration may well become a necessary condition for the successful solicitation of funds from US institutional investors. However, it is unlikely that registration in itself will be sufficient, it cautions. “Hedge funds that hope to win institutional business will have to go well beyond the dictates of the current registration requirements in terms of defining their effective internal processes and risk controls,” it says.

Nearly 95% of the hedge funds participating in the Greenwich Associates study saw their compliance costs rise in 2005. New compliance hires contributed significantly to this increase: about 90% of funds said their compliance staffing levels rose last year, with most funds experiencing increases of 10%-25%. Other significant drivers of increased compliance costs were IT expenditures and “business costs” such as fees paid to outside consultants, and the expense of preparing registration documentation and planning for registration.