Traditionally, a “hedge” is a fence or other boundary that protects one’s property. When someone “hedges their bet,” they avoid committing themselves to one specific decision—by putting something else out as a possibility. And then, of course, a hedge is an asset someone holds to protect oneself against a financial loss. Remembering those classic definitions helps in attaining a better understanding of a “hedge fund.”
Because investing in a hedge fund is an investment that protects against loss—but it’s also about avoiding the potential downsides of committing to one particular investment. And ironically enough, a hedge fund can also make investors more vulnerable to unscrupulous fund managers and risky investments.
As the Securities and Exchange Commission recently explained in an investor bulletin, hedge funds pool investors’ contributions into a single fund and then find investments to best maximize their collective asset.
Unlike other types of pooled funds (e.g., mutual funds), hedge fund managers can pursue various investments. In some cases, hedge funds are more willing to use speculative practices with investors’ money. Some hedge fund practices—investing in derivatives, short-selling stock, or using leverage to partially fund the pool’s investment—may be legal, but they dramatically increase the riskiness of an investment.
Given the riskier types of investments, typically, only “accredited investors” can invest in hedge funds. Investors meet this standard by having a minimum level of income or assets, but—in practice—it often means that most investors are institutional investors or wealthy individuals.
Given hedge funds’ wide range of investments, not all managers are required to be registered with the SEC, and their offerings don’t always have to be registered, either. And there is no set method that hedge funds must follow when calculating performance.
That said, hedge funds are not a free-for-all.
Hedge fund managers still owe a fiduciary duty to the funds and are still prohibited from fraudulent activities, just as a licensed broker would be.
Under the Securities Act, SEC Rule 10b-5, and the Advisers Act, SEC can—and will—prosecute fund managers for malfeasance such as failing to follow promised investment strategies, falsifying accounting statements, and failing to disclose conflicts of interest. And the SEC will also prosecute hedge funds that are entirely fraudulent businesses and Ponzi Schemes.
If you’re concerned that a hedge fund is defrauding investors, consider becoming an SEC whistleblower. If you bring the SEC a tip that leads to a successful enforcement action, you may be eligible for an award.
We have years of experience representing SEC whistleblowers, coupled with an SEC Enforcement lawyer on our team and an in-depth understanding of how the SEC Whistleblower Program operates. We are here to assist whistleblowers attempt to maximize their opportunity to receive a financial bounty. For a free, confidential consultation, email us or call us today at (800) 975-4345.