On September 29, 2003, following a 16-month study, the SEC staff released a report containing recommendations for changing the regulatory framework of the largely unregulated hedge fund industry. The staff's recommendations are not likely to result in rulemaking that would materially affect a hedge fund's trading strategies, and the SEC has not yet established a time line for the rule proposal that will inevitably result. Key staff recommendations that we believe will most impact our hedge fund clients include:

• Registration of Hedge Fund Advisers With the SEC

  Most hedge fund advisers currently avoid registering with the SEC under the Investment Advisers Act of 1940 by relying on an exemption that excludes from registration advisers who have fewer than 15 clients. Under the exemption, each hedge fund that is advised by an adviser counts as a single client. The staff has suggested that this exemption be changed by the imposition of a look-through provision that would count each separate investor in a hedge fund as a separate client. The recommended change would force a vast majority of hedge fund advisers to register with the SEC. This change would not apply to venture capital funds or private equity funds and would not result in public disclosure of the identities of hedge fund advisers' clients. The staff has also recommended a threshold for registration based on the aggregate amount of assets managed by a hedge fund adviser.

• Valuation Procedures for Investments in Hedge Funds

  The staff has recommended requiring registered investment companies to adopt procedures to ensure that their hedge fund investments are valued consistently with the requirements of the Investment Company Act of 1940. We expect that our hedge fund clients would be impacted by having the SEC impose some degree of an independent check on a hedge fund adviser's valuation of a hedge fund's portfolio securities.

• Disclosure of Estimated Fees and Expenses of Hedge Funds

  The staff has recommended requiring registered investment companies to disclose to investors the estimated fees and expenses of the underlying hedge funds in which they invest.

• Permitting General Solicitation for Certain Hedge Funds

  The staff has recommended that the SEC consider eliminating the prohibition on general solicitation for hedge funds that rely on Section 3(c)(7) of the Investment Company Act of 1940. The staff does not, however, recommend that the prohibition on general solicitation be eased or eliminated for hedge funds that rely on Section 3(c)(1) of the Investment Company Act of 1940.

• Examining Wider Use of Hedge Fund Investment Strategies

  The staff has suggested that the SEC consider issuing a concept release exploring the benefits that may arise from the wider use by registered funds of hedge fund strategies, such as absolute return and short selling strategies, and leverage.

The staff's report on hedge funds is likely the first step in a process that will ultimately result in some form of SEC regulation of the hedge fund industry. Based on the staff's recommendations, it does not appear likely that the process will result in rulemaking that would materially affect a hedge fund's trading strategies. At this stage, however, our hedge fund clients should continue to monitor the situation as the staff's recommendations work their way through the SEC rulemaking process. list.