NASD Watching Retailization of Hedge Funds
Are hedge funds moving down market? If so, why?
The NASD staff continues to see evidence of retailization of hedge funds, according to NASD associate general counsel Gary Goldsholle, speaking at the SIA hedge fund conference last month. The latest wave of retailization, he said, differs from the early retailization seen via the fund of hedge funds structure. More recently, the NASD’s examination staff has seen a trend towards direct investments in hedge funds by retail investors, in amounts as low as $25,000. While "that’s not necessarily a problem in and of itself," said Goldsholle, "the NASD’s resources will be deployed in areas that have an impact on retail investors."
To that end, NASD will be looking closely at marketing materials, suitability, training of personnel, and other areas when hedge funds are offered directly to retail investors, he said.
Goldsholle’s co-panelist, Schulte Roth partner Paul Roth, asked whether the NASD still views retailization as a "red flag," as the regulator had indicated in a 2003 Notice to Members, 03-07. "Is there a basic decision that has been made that hedge funds are simply not appropriate for retail investors?" he asked.
Goldsholle replied that the accredited investor definition encompasses some retail investors, and "probably should be changed by the SEC." The accredited investor definition, "at the lower end, puts you squarely at what we define to be retail investors," he said. Goldsholle noted, however, that SEC registration of hedge fund managers will address "some of the concerns" about the low accredited investor standard, since the "qualified client" standard in Advisers Act Rule 205-3 for performance fees will "raise it somewhat."
But why, exactly, are hedge funds being sold to retail investors? Goldsholle expressed concern that "as an asset class is expanded down market or to include new people, it may be done because the returns are not there." The expansion, he said, may be a way to generate revenues by increasing the base of a firm’s assets. According to Goldsholle, it is "fair to question" whether retailization is evidence that the returns of the retailized asset class "have been tapped out." The NASD’s view, he added, is not unique. "A lot of the financial press" have questioned whether the historic returns of the hedge fund asset class are sustainable, he said. "It is certainly something to consider."