A hedge fund is an unregulated aggressively managed private fund using advanced strategies offering higher returns on investments at usually higher risks than normal. Unlike mutual funds, a hedge fund requires a large amount of investment, usually by pooling together sophisticated investors with a taste for higher returns against higher risks.

In most countries, hedge funds are mostly unregulated. In the United States, hedge funds are exempted from registration and reporting requirements because of two provisions of the Investment Company Act of 1940 (Sections 3(c)1 and 3(c)7).

Section 3(c) 1 exempts “any issuer with less than 100 investors” and Section 3(c) 7 exempts “qualified purchasers” because they are not considered an “Investment Company”.

The collapse of Long Term Capital Management in 1998 prompted calls for regulating hedge funds. Recently, the US Securities and Exchange Commission (SEC) and the UK Financial Services Authority (FSA) seem to be moving in that direction, especially with President Barack Obama’s plan to overhaul the financial sector, and recent EU regulations affecting the UK’s hedge fund industry.

President Obama’s plan seems to involve mandatory registration and surveillance. The European Union legislation will force hedge funds and other financial institutions including all asset managers and investment companies to limit bonuses as well as adopt other requirements.

Recently George Soros told the congressional hearing of the hedge fund market, that “(the hedge fund market)….. justifies greater regulation.”

He said, “Clearly, hedge funds use leverage, and they contribute to market instability in times like the present when we are experiencing wholesale and disorderly deleveraging.”

The billionaire added “systemic risks need to be recognized and more closely monitored than they have been until now. The entire regulatory framework needs to be reconsidered and hedge funds need to be regulated within that framework.”

Issues concerning hedge fund growth and how this impacts a broader market have taken center stage with the increasing popularity of hedge funds year after year. Some even think that regulating hedge funds would be a mistake as hedge funds by design are intended to be extremely flexible.

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