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News March 13, 2006 Issue

CT Legislature Considers Creation of Hedge Fund 'Anti-Fraud Unit'

Did you hear the one about the Connecticut General Assembly trying to pass its own hedge fund disclosure law?

As initially introduced, Connecticut House Bill No. 5297 would have required certain hedge fund managers to disclose to prospective fund investors, upon request, "detailed portfolio information relative to the assets and liabilities of such fund." The disclosure requirement would have kicked in if the hedge fund received a certain percentage of investments from retail investors "who do not meet the standards for participation in a nonpublic offering" and/or pension funds.

The bill was gathering steam. On March 7, Connecticut attorney general Richard Blumenthal testified in support of the measure, noting that "more disclosure" is necessary to ensure that investors understand investment risk and appreciate conflicts. Investors, he said, "must have key facts to effectively monitor hedge fund activities," he said. The billís "concept of disclosure," he said, "is welcome and positive," although he added that "[m]ore needs to be done."

The punchline, of course, is that nearly all state regulation of SEC-registered advisers is federally preempted. Under Section 203A(b) of the Advisers Act, added by the National Securities Markets Improvements Act of 1996, "state investment adviser laws that, for example, establish recordkeeping, disclosure, and capital requirements will no longer apply to advisers registered with the Commission," as the SEC put it in its 1996 proposed NSMIA implementing release.

So: Even if the legislature passed the bill, it would have had no legal effect over any hedge fund manager registered with the SEC.

It looks like someone finally let the Connecticut lawmakers in on the joke. On March 9, the Connecticut Banking Committee came up with a new and improved hedge fund bill. As amended, H. 5297 would establish a "hedge fund anti-fraud unit" within the Connecticut Department of Banking. "The unit, upon receipt of a complaint or on its own initiative, may investigate cases of alleged fraud involving any hedge fund located in the state," said the bill. The Banking Department would receive an appropriation of $250,000 to establish the new unit. Under NSMIA, states can continue to investigate and bring enforcement actions against SEC-registered advisers for fraud.

Meanwhile, Blumenthal is expected to make an announcement about the composition of his hedge fund working group in the next few weeks. The group, he testified, will be "comprised of investors, managers, regulators, legislators and advocates" and will "examine other disclosures and measures that may be appropriate."