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SEC chief calls hedge fund rules `inadequate'

Agency has filed at least 90 fraud cases in 4 1/2 years

Securities and Exchange Commission chairman Christopher Cox said that hedge fund regulation is ``inadequate" and that Congress may need to demand more oversight of the $1.2 trillion industry.

``The commission stated, when we adopted the hedge fund rule in 2004, that its then-current program of hedge fund regulation was inadequate," Cox told the Senate Banking Committee in Washington yesterday. ``I believe that is once again the case."

The SEC's efforts to keep tighter tabs on the industry were dealt a blow last month when a federal appeals court struck down an agency rule requiring hedge fund managers to register and submit to random inspections, giving Congress more reason to consider legislation.

Regulators are becoming more concerned about hedge funds because of the power they wield in financial markets and the growing number of frauds. As the industry's assets doubled in the past five years, funds including Bayou Group, Manhattan Investment Fund, Lancer Group, and Philadelphia Alternative Asset Management collapsed, saddling investors with losses.

``You have this uneasy feeling about a whole area here that we don't know very well, and we don't fully understand," Senator Paul Sarbanes, a Maryland Democrat who sits on the Senate Banking Committee, said at yesterday's hearing. Lawmakers need a better sense of what hedge funds are doing, Sarbanes said.

The SEC has brought more than 90 enforcement cases against hedge funds in the past 4 1/2 years, up from four in 2001, Cox said.

Cox said regulators ``must move quickly to address the hole" left by the US Court of Appeals ruling. While ``some improvements will be possible through administrative action, others, however, may well require legislation.".

Cox said the SEC is preparing alternatives aimed at restoring parts of the rule, while ensuring they will stand up to litigation. The original proposal would have made clear that the SEC had the primary responsibility in regulating hedge funds, more than other federal agencies or the states.

``We are working as quickly as we can to try and, if not put Humpty Dumpty back together again, then to erect something more sturdy that will accomplish some of the same objectives," Cox said.

The registration rule took effect last February and was pushed through in a 3-2 vote by Cox's predecessor William Donaldson. Cox yesterday offered his most extensive defense of the proposal since a lawsuit by Phillip Goldstein, manager of Pleasantville, N.Y.-based Opportunity Partners LP, won the federal court decision that struck it down June 23.

The SEC hasn't ruled out appealing the Goldstein decision to the US Supreme Court, Cox said after the hearing. The agency is weighing the cost and ``potential reputational damage" against the probability of success, he said.

Former chairman Donaldson said ``the SEC needs to have the right to look at your records, the criminal records of the managers, how they're investing the money, just to make sure nothing fishy is going on. Any time these companies are buying and selling securities, they're dealing with the public."

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