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Little investors falling prey to shady small-time operators

By
John Aidan Byrne
Published April 26, 2015, 8:19 a.m. ET

Average Joes are finding big trouble in little pools.

The smaller investors looking to land big hedge-fund and private-equity returns are falling prey to small-time operators, according to an industry study.

While the bulk of asset managers are registered and count billions of dollars in supersize funds under the watchful eyes of regulators, smaller funds with $50 million to $100 million or so, which lure mom-and-pop investors, are escaping adequate government oversight, experts say.

The five-year bull market has pulled in assets galore — $2.47 trillion globally in hedge funds alone, according to BarclayHedge, an industry data company that conducted the study.

“The overwhelming number are smaller funds,” BarclayHedge President Sol Waksman said. “And if they fall below a certain size, they are not required to register with the Securities and Exchange Commission. So if they are not registered, they may fall off the radar.”

Despite the Dodd-Frank Act’s aim to restore the financial system’s integrity after the 2007-08 financial crisis, its effort to keep better tabs on smaller hedge funds and private-equity funds has failed, according to Michael Minces, general counsel at Blue River Partners and former chief compliance officer at Highland Capital Management.

Before Dodd-Frank, hedge funds and private-equity funds with $25 million in assets under management typically had to register with the SEC, he said.

Now both hedge funds and private equity can have as much as $150 million in assets before the required registration is triggered, Mince notes.

After the threshold was raised, he added, the SEC shifted the burden of oversight for these smaller funds to often ill-equipped and under-resourced state regulators in New York and other major centers of fund management.

Unfortunately, that came with unintended consequences.

While the fraud can cut across minnow hedge funds and private-equity funds, it’s the small hedgies — investing in everything from stocks to crude oil and shorting the markets — that have grabbed the limelight recently for fraud and poor management. And that’s often only after investors have been sucker-punched.