SEC’s Hedge Fund Focus to Include Review of Funds That Outperform the Market

Recently, during Congressional testimony, Robert Khuzami, the Director of the SEC’s Division of Enforcement (Enforcement Division), faced tough questions regarding the SEC’s response to the Madoff scandal.  In response, Khuzami revealed an investigative initiative concerning hedge funds.  The Enforcement Division is now focusing on hedge funds that outperform “market indexes by 3% and [are] doing it on a steady basis.”  Khuzami referred to such performance as “aberrational,” and stated that Enforcement is “canvassing all hedge funds” for such “aberrational performance.”  This initiative raises a number of questions.  Should skilled portfolio managers (and their investors) bear the burden and costs of an SEC investigation just because they have returned more than the market?  How and why did the Enforcement Division determine to set the threshold at three percent?  Does the three percent threshold reflect “aberrational” performance, as Khuzami suggests?  What is considered outperformance on a “steady basis”?  Will the Enforcement Division focus on performance on a quarterly basis, or over one year, three years, or longer periods?  In a guest article, Fredric Firestone, Eugene Goldman and Michael Ungar – all Partners in the White Collar & Securities Defense Practice Group at McDermott Will & Emery LLP, based in Washington, D.C., and all Enforcement Division alumni – address these and related questions, and explain the implications of the new enforcement initiative for hedge fund managers.

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