* Rule would apply to registered investment advisers
* FinCEN expects to publish proposal in first half of 2013
* Insider trading can trigger suspicious activity reports
By Emily Flitter
NEW YORK, Jan 4 U.S. financial regulators are
pushing to turn hedge funds into informers on the white collar
The Financial Crimes Enforcement Network (FinCEN) is working
on a rule that would require U.S. hedge funds to file formal
reports notifying U.S. authorities of any suspicious trading by
employees or outside parties, the regulatory agency said.
The rule being crafted by FinCEN, part of the Treasury
Department, would force the $2 trillion hedge fund industry to
police itself in much the same way banks, brokerages and mutual
funds are required to do by filing suspicious activity reports
(SARs) with the unit.
Steve Hudak, a FinCEN spokesman, said a proposed rule for
the hedge fund industry could be filed for public comment some
time in the first half of this year.
But the rule, which would cover activities such as insider
trading and money laundering, will force funds to spend more
money on building out their compliance and legal departments.
Hedge fund lawyer Ron Geffner said he expects many in the
industry will oppose the new rule as being both intrusive and
"Anytime there's any regulatory hook into a firm, it's like
a domino," said Geffner, a partner at the law firm Sadis
Goldberg in New York. "When taken together, all of the rules and
regulations, both new and revised, serve to intimidate
A spokesman for the largest hedge fund trade group, the
Managed Funds Association, did not respond to a request for
The measure also could heighten tensions in the the
hyper-aggressive hedge fund world as it could put firms and
their employees in a position to snitch on their competitors.
FinCEN's move is not entirely new. In 2003, the agency
began looking at imposing a SARs requirement on hedge funds, but
eventually withdrew a proposed rule in 2008 after deciding it
was too hard to define a hedge fund and enforce the requirement.
The agency now believes the new mandate in the Dodd-Frank
financial reform law that requires U.S. hedge funds to register
as investment advisers gives it the ability to require hedge
funds file SARs.
James Freis, a former FinCEN director, said the new rule is
long overdue and would require hedge funds to do more due
diligence on their employees and customers. He said it also
would require hedge funds to hire staff who are well-versed in
anti-money laundering procedures, which is one of the main
reasons banks are required to file SARs.
"Suspicious activity reporting would put an affirmative
obligation upon investment advisers, including certain hedge
funds, to notify the authorities of suspected illegal activity,"
said Freis, now an attorney with the law firm Cleary Gottlieb in
Freis served as the director of FinCEN until September, when
he was forced out over disagreements with Treasury officials
over FinCEN's priorities, according to a person familiar with
During his tenure he was an advocate for a hedge fund
The filing of SARs reports took on new urgency for the
financial industry in the wake of the Sept. 11, 2001 attacks on
New York and Washington as federal lawmakers moved to require
banks to become more aggressive in tracking money flows by
The SARs reporting requirement is one that banks and brokers
do not take lightly. Jay Hack, a partner at Gallet Dreyer &
Berkey in New York, said many banks file a "defensive SAR" when
they see something even remotely suspicious to keep the
In the brokerage world, the SARs requirement has provided
securities regulators and federal prosecutors with leads about
investment scams and insider trading rings, securities lawyers
From 2003 to 2011, securities firms filed more than 110,000
SARs, with most of those involving incidents of money laundering
or unusually large transactions, according to FinCEN. Roughly,
3,500 of those SARs involved a suspected insider trading
incident. Final numbers for 2012 are not yet available.
But the agency reports that the number of SARs filed
involving insider trading was up 34 percent in 2011 from 2010.
The increase came at a time when U.S. authorities were engaging
in a massive crackdown on insider trading in the hedge fund
industry that has led to more than 70 convictions.
Many hedge funds maintain relatively small compliance and
legal departments, often preferring to hire outside contractors
to perform that work.
SAC Capital, the $14 billion hedge fund with 900 employees
that has drawn scrutiny in the insider trading investigation, is
rarity in that it has more than 30 people working on compliance
matters. People familiar with SAC Capital, which declined to
comment, said the firm's compliance team is one of the largest
in the hedge fund industry.