SEC rule triggers sharp increase in number of RIAs

FWR Staff

3 August 2006

But with that rule thrown out in court many new-minted RIAs may jump ship. The Securities and Exchange Commission (SEC) requirement for hedge funds to register with the government agency as investment advisors has swelled the ranks of RIAs, according to the sixth annual Evolution/Revolution report on the investment-advisor profession, conducted by the Investment Adviser Association (IAA) and National Regulatory Services (NRS).

The total number of SEC-registered investment advisers is 10,290, up from 8,614 last year. The total includes 1,139 "entities" with less than $25 million in assets under management that register under special provisions of the Investment Advisers Act of 1940 .

Total assets under management increased from $26.8 trillion in 2005 to $31.4 trillion by 7 April 2006.

May not stay

"The big story is that the number of SEC-registered hedge fund advisers has increased dramatically as a result of the recently contested regulation requiring many hedge fund advisers to register under the Investment Advisers Act by February 1, 2006," says Keith Marks, manager of the NRS' Investment Adviser Services group.

The new report, based on SEC "ADV" filings, shows that there are 2,423 RIAs with at least one hedge-fund client, accounting for 23.6% of all RIAs. Of those, 1,336 can be characterized primarily as hedge-fund advisors because hedge funds make up at least 75% of the clientele. Over a thousand -- 1,092 to be exact -- firms registered as advisors in the past year through 7 April 2006.

But some of these newly minted RIAs may soon peel off, according to Marks. "It is certainly possible that many of these hedge fund advisers will withdraw their SEC registration in light of the recent court ruling that invalidates the SEC's registration requirement."

In June 2006, the U.S. Court of Appeals for the District of Columbia Circuit ordered the SEC to review its rule on hedge-fund oversight it adopted in October 2004 -- a rule that went into effect on 1 February of this year. The court said it was rejecting the rule primarily because it disagreed with the SEC's classification of investors in a hedge fund as clients of the fund's adviser.

In testimony this month before the Senate Banking Committee SEC chairman Christopher Cox said he was pushing for new regulations on hedge funds -- largely, he said, because fraud and other kinds of malfeasance on the part of hedge-fund managers -- which he says is on the rise -- is harming small private investors.

"The potential for retail investors to be harmed by hedge-fund risk remains," Cox told members of the Banking Committee. "And the growth in hedge-fund fraud that we have seen accompany the growth in hedge funds implicates the very basic responsibility of the SEC to protect investors from fraud, unfair dealing and market manipulation."

There were 2,073 new hedge funds created in the U.S. last year, according to the Baltimore Sun -- about one an hour during business hours.

The IAA, formerly the Investment Counsel Association of America, is a Washington, D.C.-based industry association that provides advocacy, educational, and business services to about 450 advisory firms. All together its members manage around $5.5 trillion for private and institutional clients.

Lakeville, Conn.-based NRS is a compliance consultancy to investment advisors, broker-dealers, investment companies and insurance companies. It's part of Securities Data Publishing, a subsidiary of Thomson Financial.