SEC Hedge Fund Registration is a Joke

Posted by Josh Friedlander | 4 Comments

Politicians are continually whining about how hedge funds need to be registered. Many already are because some large investors insist on it. Others don’t register. They don’t need to to raise money and they don’t want the hassle. But it’s not much trouble, really, because the registration reporting requirements, so far as I can tell, are a joke.

Attention Mary Schapiro and the U.S. Senate: before you mandate registration you need to make it meaningful.

Click to enlarge.

Why is SEC Registration a joke? Well, aside from the fact that the SEC Form ADV web site (where the registration forms are publicly available) looks like it was built in 2000 and it actually GOES TO SLEEP every night, making it meaningless for certain foreign markets, even when the site is functioning it offers vague information of dubious freshness.

In particular, some major pieces of information revealed by a registered investment adviser, such as asset size, ownership, and clientele are deficient in major ways:

Asset size
As far as I can tell, most hedge funds update their registration once a year. They seem to do it whenever they want to, but probably on the anniversary of their first date of filing. Unlike a quarterly 13F filing, which must include data as of a certain date, the SEC ADV filing does not appear to require any particular date of reference (whether midyear, yearend or quarterly).

The result is that even though one can tell the date of the update (on the signature page), information that one might want to record, such as a firm’s total assets under management (in Part 1a. Item 5.) is recorded for an arbitrary date.

Many firms like to give yearend figures if they are filing in February or March, but for all anyone knows they could be giving current numbers. The form doesn’t say. In addition to making it difficult to use this information to measure the asset growth of individual firms, it is also impossible to aggregate information on the hedge fund industry.

And since filings are presented in HTML code and not in any easily portable format (such as an excel spreadsheet, database or xml standard), it is also impossible to search or sort the SEC database by such factors as date of filing, size of firm or any other metric. All anyone can do is search for a firm by name. The HTML pages do appear to be driven from a database (the files have an aspx extension, meaning they are driven from some kind of database, which further means the SEC is likely too lazy to make a real search protocol possible).

What about fund assets (Schedule D. Section 7.B.)? Surely these are date stamped? No, they’re not. At least the SEC requires firms to itemize the assets of all their partnerships, right? Who knows? I’ve seen at least one firm that refuses to do so: Caxton Associates. In their current filing, dated 2/3/09, all but one of Caxton’s funds lists assets of $0. Here is their explanation:

EACH OF CAXTON HEALTH HOLDINGS LLC [here they include a list of all the funds] ARE ENTITIES ASSOCIATED WITH OR MANAGED BY CAXTON ASSOCIATES, L.L.C. ALL OF THESE ENTITIES ARE PRIVATELY OWNED AND THEIR SECURITIES ARE NOT OFFERED TO CAXTON CLIENTS. ACCORDINGLY, IN ORDER TO MAINTAIN THE PRIVACY OF THE ENTITIES, THE VALUE OF CURRENT ASSETS OF THESE ENTITIES HAS BEEN DISCLOSED AS $0. CAXTON ASSOCIATES, L.L.C. IS THE MAJORITY OWNER OF [the funds]. INVESTORS ONLY INVEST IN A RESPECTIVE FEEDER FUND. AS SUCH EACH MASTER TRADING VEHICLE’S TOTAL ASSETS WILL INCLUDE THOSE ASSETS DISCLOSED BY THE RESPECTIVE FEEDER FUNDS.

What is the point of forcing Caxton to list its related partnerships and assets if they actually don’t have to disclose the assets?

Ownership
Schedule A and B of Part 1a. have this info. It’s current as of the date of the filing, right? Maybe.

Here’s what Palo Alto Investors says about the timeliness of its ownership, which is tucked away in Schedule D (miscellaneous):

THE OWNERSHIP CODES SHOWN IN SCHEDULE A TO PART 1A OF REGISTRANT’S FORM ADV ARE BASED ON THE RESPECTIVE CAPITAL ACCOUNT BALANCES OF REGISTRANT’S MEMBERS AS OF DECEMBER 31, 2006. BECAUSE REGISTRANT’S PROFITS AND LOSSES FROM DIFFERENT SOURCES ARE ALLOCATED AMONG ITS MEMBERS IN DIFFERENT RATIOS, THESE CAPITAL ACCOUNT BALANCES CAN AND DO CHANGE DURING THE COURSE OF EACH YEAR. IN ADDITION, REGISTRANT’S MANAGER MAY CHANGE THE PERCENTAGE INTERESTS OF REGISTRANT’S MEMBERS IN REGISTRANT’S VARIOUS SOURCES OF PROFITS AND LOSSES EACH YEAR, WHICH CAUSES THEIR CAPITAL ACCOUNT BALANCES TO CHANGE FROM YEAR TO YEAR.

This registration update was filed on 03/26/2008, and the disclaimer says the ownership information is more than a year old. If the information doesn’t have to be updated at least once a year, why require an updated filing at all?

Not that an up-to-date filing (and how would one know if a filing was up to date?) necessarily tells you anything. Check out the filing for Standard Pacific Capital LLC. Schedule A lists these shareholders and control persons:
STANDARD PACIFIC PARTNERS, L.P.
COLE-FRIEMAN, KARL, ALAN
VENKATESAN, RAJ, DAVID
DILLARD, GEORGE, DOUGLAS

Set aside for a moment the unreadability of the lovely “Last name, First Name, Middle Name” syntax and wonder: “What is Standard Pacific Partners?” Who owns it? That question is answered in Schedule B, of course. Standard Pacific Partners is owned by:
STANDARD PACIFIC PARTNERS, LP (itself!?) and SPH GP, LLC (what’s this!?).

SPH isn’t mentioned anywhere else in the filing. It is not registered. It is a phantom entity. Now, because I am a Google Champion, I found out from an obscure online spreadsheet that ‘SPH’ stands for ‘Stock Pairs Hedging.’ It’s some kind of fund. But who owns it and who really owns Standard Pacific Capital? What is the point of disclosing your shareholders if you can disclose phantom entities and don’t really have to disclose your shareholders? Let me be perfectly clear: I don’t blame Standard Pacific from disclosing only what it has to. I wouldn’t want anyone knowing intimate details about my company. That’s why, if the SEC wants this information, it should force true disclosure. It should be mandatory that hedge funds reveal exactly which human beings own what and as of what date.

Clientele
This section (Item 5. Section D.) couldn’t possibly be any less useful without ceasing to exist at all. The form asks filers to “Indicate the approximate percentage that each type of client comprises of your total number of clients.” But it’s often the case that clients overlap: a pension might represent 5% of a firm’s assets and also be 100% invested in the firm’s hedge funds. The form might further say that hedge funds hold 10% of a firms’ assets. It’s possible that the pension’s assets represent half of the firm’s hedge fund assets, but given the way the SEC requests and presents these two pieces of data (% of hedge fund assets, % of pension assets), one could never be certain that the pension fund is even invested in the firm’s hedge funds.

Because client percentages can overlap, figuring out anything meaningful (such as percentage of pensions that are hedge fund investors) is like solving an SAT problem. As in:

“A hedge fund firm has 11 to 25 clients. 20% of the firm’s assets are invested in “pooled investment vehicles” (such as hedge funds, but they could be private equity funds or real estate funds). Of the firm’s many clients, 85% are charitable organizations.

Please give the smallest and largest percentage of the firm’s charitable organization clients that must also be investing in its hedge funds.”

One can figure out a range (5%-20% if the pooled vehicles actually are hedge funds and not private equity or real estate funds), but it doesn’t offer precise information. Again, trying to use this sort of disclosure to determine industry-wide information would be geometrically less precise (as we’d be compounding a series of guesses). So, the SEC can’t really say it has any idea how much pension money is invested in registered hedge funds. Wouldn’t that be a useful piece of information?

A useful client breakdown wouldn’t be a test. The SEC should require firms to disclose who is investing in what or, at least, what types of investors are investing in what types of products/services. If firms want to argue that this is an undue burden, that’s baloney. They know exactly how much money they are managing for each client and what types of organizations or individuals these clients are (pensions, high net worth individuals, etc.). There are always complexities, but it would be a mere formality to export this information to a spreadsheet, label the clients by number instead of name (if we want hedge fund clients to remain anonymous) and send that information to the SEC. It’s a matter of will, not a matter of ability.

Conclusion
SEC registration does not require enough precise information to help investors or the agency. The information that is supplied to the public is presented in such a way as to make it useless. Registration certainly isn’t anything like a “high bar” and insisting that hedge funds register isn’t a “good first step.” It’s no step at all.

Real regulation would start with a real registration. Real questions. Real answers. Who owns your firm? Who manages your firm? How much money do you manage in each of your funds? What were their holdings as of the date of filing? How much do you manage in separate accounts? Who are your clients? Please provide all the above information at the end of each quarter. That would be a good starting point. What we have now, I’ll say it again, is a joke.

Comments