SEC To Watch Broker-Dealer, Hedge Fund Ties

Date: Wednesday, September 13, 2006
Author: Jaime Levy Pessin, Dow Jones Newswires

By Jaime Levy Pessin
Of DOW JONES NEWSWIRES

NEW YORK -(Dow Jones)- The Securities and Exchange Commission will be monitoring hedge funds through their dealings with broker dealers, and those relationships will come under more scrutiny, the commission's director of enforcement said Wednesday.

Linda Chatman Thomsen, speaking in New York, said the SEC would be paying attention to whether broker-dealers were ignoring red flags that were readily apparent in their dealings with hedge funds.

"What we're seeing in cases is beyond a blind eye and into aiding and abetting," Thomsen said at a seminar sponsored by the Practising Law Institute. "Activities with hedge funds are going to be something we're going to focus on."

Hedge funds are among the most active traders of stocks, bonds and derivatives. But the SEC lost its already limited ability to directly oversee them in June, when a federal court rejected a controversial rule requiring hedge-fund managers to register with the SEC.

Broker-dealers like Goldman Sachs Group Inc. (GS) and Morgan Stanley (MS), which do lots of business with hedge funds and whose activities are regulated by the SEC, may give the commission an indirect look at what funds are up to.

Thomsen said the SEC found out about late trading and market timing in mutual funds by hedge funds through the lens of broker-dealers. And she said broker-dealers should be as quick to report insider trading by large hedge funds as they are to report such trading by smaller investors.

"The regulated entities are our window into hedge funds," Thomsen said. "Everybody's doing business with them. We're going to find out what they're doing through what we can see."

Thomsen also addressed the controversy over backdating of options, saying that attempts to cover up improper activities would trip up some companies: "It's not what you do that gets you into trouble, it's what you do after you did what you did."

She added, "There's not a thing wrong with granting in-the-money options, but shareholders have to say it's OK... And you have to account for them a certain way." She said compliance procedures need to be updated to deal with changing options practices.

More than 100 cases of suspected backdated options are being investigated, Thomsen said, although she didn't expect all of them to develop into enforcement actions.

"People generally don't like rich people lying and cheating," she said, "and that is how this is resonating."

-By Jaime Levy Pessin, Dow Jones Newswires; 201-938-4546; jpessin@dowjones.com