Hedge Funds in the Crosshairs

By virtually any measure, 2008 was a watershed year on the hedge fund enforcement front. Driven by the turmoil that has reshaped our capital and credit markets, enforcement efforts soared to new heights. Regulators and prosecutors redefined their enforcement priorities, commenced an unprecedented number of investigations and enforcement actions, and, according to a senior SEC insider, reached out to and cooperated with domestic and foreign agencies in a manner that has not been seen in at least 30 years. Explaining the unusually intense scrutiny that regulators placed upon hedge funds in 2008, Bruce Karpati, who coordinates the SEC’s Hedge Fund Working Group out of the New York Regional Office, suggested that, given the economic climate, ”half to two-thirds of hedge funds might go out of business”- and, as the aphorism goes, desperate times may lead hedge funds to take desperate measures. And these measures will continue to draw the SEC’s attention under the Obama administration.

Since 2000, the SEC has reportedly brought 145 actions involving hedge funds; and since 2003, the number of actions involving hedge funds each year has been in the teens or twenties. In 2008, that trend continued with the filing of 22 hedge-fund-related enforcement matters. In addition, the Department of Justice brought five hedge-fund-related criminal actions. While these numbers may seem unexceptional given the unprecedented scrutiny that hedge funds faced, the figures should be considered in light of the fact that 2008 saw: (a) the filing of a significant number of large, complex, or novel cases; (b) the culmination of similarly large, complex, or novel previously filed actions; and (c) the commencement of several broad industry-wide sweep investigations focusing on the activities of hedge funds and other market participants- all of which likely required the deployment of significant regulatory and prosecutorial resources. One need look no further than the highly publicized civil and criminal actions brought against Bernard L. Madoff for allegedly defrauding his advisory clients (hedge funds and others) out of billions of dollars in what might be the largest financial fraud in history. Investor losses from the fraud could reach $50 billion.

The take-away is clear: hedge funds were under extraordinary regulatory scrutiny in 2008 – particularly so once the economic crisis came to dominate the daily news-and that level of scrutiny is expected to continue, if not intensify, in 2009. In our article [link to article] , we review those enforcement priorities that dominated the headlines in 2008 and look to remain at the forefront throughout 2009. Along the way, we also offer advice to hedge funds and their advisers about how to navigate the increasingly hostile regulatory landscape. Much of the information presented is based on our review of cases filed and public sources describing enforcement initiatives and investigations. In addition, we have incorporated salient comments and observations made by senior regulators and prosecutors at a Nov. 24, 2008 Practising Law Institute Conference in New York on Hedge Fund Enforcement and Regulatory Concerns.

The article, which was recently published in the Alternative Investment Law Report, is available here.