How to discipline a hedge fund

More stringent financial regulation is a big issue these days. One of the surprises is that hedge funds seem to have fared much better than anyone could have expected. Not so long ago, people were bracing for an onerous set of new regulations. But that hasn't materialized. Hedge funds, so far anyway, seem to be sliding under the radar. The industry can certainly live with a registration requirement; many do so voluntarily already. And a systemic risk regulator with power over funds doesn't seem all that onerous right now. 

But before hedge funds think they are in the clear they may want to take note of a theme put forward by AllAboutAlpha.com: The new regulators, in essence, will be investors. They certainly seem empowered these days to seek the kind of changes that would have fallen on deaf ears in the past. 

Consider Swiss bank Union Bancaire Privée, which was burned by Bernard Madoff. The bank is threatening to pull billions of dollars from hedge funds if they don't start using a full-time independent administrator. These are big names: Renaissance Technologies, D.E. Shaw & Co., SAC Capital Advisors and Caxton Associates. The Wall Street Journal said at least one ended up complying.  

A more recent example is Maverick Capital. After some big losses in 2008, it is bent on retaining investors. To that end, it will hire an independent auditor to verify his funds' activities and provide the results to investors, the New York Post reports. While most funds undergo an annual audit, Maverick is taking the unusual step of subjecting itself to a quarterly review. 

A recent report from State Street suggests that investors will demand some key changes from hedge funds: Independent custody of their investments (ah, there's the State Street angle); complete clarity regarding accounting of funds and the transfer/withdrawal of assets; independent asset valuations and portfolio pricing, particularly for less liquid assets; independent risk analysis and stress-testing. Not to mention more favorable redemptions terms and pay policies that align the fund with the investor. 

The big funds are already moving in this direction, which most people regard as a good thing. We have to regard this as good news. Can investors impose discipline? What do you think? - Jim