Hedge funds that invest across the capital structure, including bank debt and public securities, are likely to come under increased scrutiny when the Securities and Exchange Commission requires them to become registered investment advisors next year. The public/private issue has been a hot topic in the loan world for years, but is growing in importance as investors and trading desks play in multiple markets. It even contributed to realignment within JPMorgan, which moved its bank debt trading onto the public side from the private side of the informational wall to minimize compliance issues (LMW, 2/11).
Hedge funds that are active in the bank debt space are aware that if they are in receipt of Material Non Public Information (MNPI), they cannot use it to benefit in public securities. Indeed the distressed bank debt arena has long been the domain of hedge funds. But according to Marc Baum, principal of the Solel Group, a number of hedge funds have not traditionally been trained or structured to deal with MPNI and will need to ramp up their procedures. "These issues were here regardless, but the SEC will know who the investment advisors are and will have a much clearer idea of their strategies," he said.
He explained that the compliance issues are greater if they are routinely receiving MNPI, This syndicate level information could include revolver levels, loan documents and any breach of covenants.
When the SEC starts inspecting more hedge funds, the agency will be looking for firms to have a written policy that establishes rules for trading public and private bank debt, said Howard Rubin, senior managing director of Boldwater Capital Management, a firm that only trades on the public side. But even hedge funds, just playing in the public arena, need to be careful. It is very easy for firms that only trade public securities to get hold of private information so firms are really acting on an honor system that says they will not use the private information to make decisions about trading public securities, he added.
The biggest pressure will be for firms to show they are adhering to their own policies, said Rubin. It will be very difficult for the SEC to prove someone used private information to influence a move they made in public securities, he added.