States Prepare for Expanded Regulatory Role

State regulators are gearing up to police several thousand hedge fund operators that will be forced to register at the state level under the pending financial-reform bill.

The Dodd-Frank Wall Street Reform and Consumer Protection Act, which is headed toward final passage by the Senate as early as this week, requires hedge fund managers with less than $100 million of assets to register with their appropriate state regulator. Across the U.S., some 4,500 managers, including fund-of-funds operators, fit the bill, according to Hedge Fund Research. While the smallest firms already are required to register at the state level, thousands of others will become the responsibility of state regulators within one year of the bill's signing.

In many states, officials aren't waiting for President Obama's signature to prepare for the expected onslaught. At a meeting of the North American Securities Administrators Association (NASAA) earlier this month, regulators from California, Michigan and other states said they planned to add staff to examine hedge funds and other investment advisors that will soon come under their jurisdiction. Officials representing 45 states signed an agreement pledging to cooperate when it comes to registering and monitoring fund managers.

In Connecticut, home to many of the largest U.S. hedge fund operations, officials are reviewing their registration process and oversight functions. They also are expected to hire additional personnel to handle the increased workload.

For now, states have wide latitude when it comes to implementing their responsibilities as hedge fund regulators. In some states, for instance, there's little oversight beyond the initial paperwork, while in others fund managers are subject to inspections by state examiners. But Denise Voigt Crawford, the Texas Securities Commissioner, said she expects states eventually will standardize their procedures for registering and monitoring hedge funds.

"We're not trying to build an empire, but we've been very worried about the over 3,000 investment advisors that [currently] fall under SEC jurisdiction that have never been examined," said Crawford, who is president of NASAA. "We're not looking for more work or responsibility, but somebody has to do this job."

A handful of states are expected to see the bulk of new hedge fund registrations, including California, Connecticut, Illinois, Massachusetts, New Jersey, New York and Texas. John Brunjes, a hedge fund lawyer with Bracewell & Giuliani who formerly worked in the Connecticut Attorney General's Office, said hedge funds shouldn't assume that switching from federal to state jurisdiction will mean less oversight.

"In states like Connecticut and others with large numbers of funds, this has to be taken very seriously," he said. "It would be a very bad error in judgment to treat state regulators as children of a lesser god compared to the SEC."

Some states may see their new authority as an opportunity to boost revenue. In Texas, for instance, the state regulator's budget is only $10 million, but the office generates $130 million a year in fines and fees for state coffers.

But Ron Geffner, a hedge fund lawyer at Sadis & Goldberg of New York, warned that if state regulators came down too hard, fund managers would flee across state lines. "There is a lot of speculation about what states will do, but it's premature to say they will add new fees or otherwise crack down," he said. "Regulating funds in a way that is counter-productive for business could backfire on the state tax collector."

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