It’s official. In a highly anticipated move, the Securities and Exchange Commission on Tuesday voted 3-2 in favor of requiring hedge fund managers to register as investment advisors with the agency.

The mandate, which will take effect in February 2006, will enable the Commission to collect more information on the rapidly growing investment product and give the SEC staff the ability to conduct examinations of the funds. The new requirement will force hedge funds of more than $25 million in assets to implement several new recordkeeping procedures, which opponents to the rule say will be costly and unnecessary.

The new rules will also require funds to put in compliance controls as well as provide potential investors with more information. Currently, information about hedge funds is sketchy. Industry assets in the increasingly popular product are thought to be between $850 billion and $1 trillion. Furthermore, several at the Commission have expressed in recent months their concerns about the role hedge funds play in the capital markets and the little that is currently known about them.

Chairman William Donaldson said in an open meeting of the SEC on Tuesday that with the product increasing in size and instances of fraud on the rise, it is difficult to deter or discover such activity before it happens due to the Commission’s current lack of oversight and inspection authority. He said that hedge funds are playing an increased role in the market scandals of the last few years and that the SEC needs more power to not only punish fraud, but to help it prevent future meltdowns at some hedge funds.

The highly publicized near-collapse of hedge fund Long Term Capital Management five years ago put the products on the SEC radar. And hedge funds, such as Eddie Stern’s Canary Capital Partners, played key roles in the mutual fund industry’s market-timing and late-trading scandal.

However, the SEC’s Commissioners were divided on the subject of hedge fund regulation. Chairman Donaldson, a Republican, crossed party lines and voted with Democratic Commissioners Harvey Goldschmid and Roel Campos. Republican Commissioners Paul Atkins and Cynthia Glassman voted against the rule. "This hedge fund proposal is a disappointment to me on many levels," Glassman said. "Procedurally, this proposal was rushed through the rulemaking process and appears to have been a fait accompli from its inception."

Glassman said the new rule will pile on more work on an already overtaxed examination staff and will not significantly help prevent future problems in the hedge fund industry. She also argued that alternative solutions were not properly explored or considered. "While I agree, as I have all along, that we need more information on hedge funds, I disagree with this solution," she said. "The comment letters in support of this proposal are not persuasive, and the comment letters against this proposal, which represent the vast majority of submissions, raise many of the same concerns that I did. I believe it is the wrong solution to an undefined problem using an ineffective examination model."

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