Subject: File No. S7-30-04
From: S Waters

September 16, 2004

9/15/2004
Jonathan G. Katz, Secretary
U.S. Securities and Exchange Commission
450 Fifth Street NW
Washington DC 20549-0609
submitted electronically to rule-comments@sec.gov

Re: File No. S7-30-04
Request for Comment on Hedge Funds

Mr. Katz,

I am writing as an individual investor to comment on the SECs proposed registration of hedge fund advisers. Registering hedge fund advisers will help individual investors, particularly retirees, avoid undue risk when investing their life savings.

Definition of Private Fund

Labeling hedge funds is critical. Today, identifying whether an investment is a hedge fund can be almost impossible for the individual investor. My family had the experience of an investment advisor denying, in writing, that limited partnerships his firm purchased into a family members account were in fact hedge funds. We learned months after the purchases that these investments fulfilled all of the requirements and more to be considered hedge funds under the SECs new proposed Private Fund rule:

The products were excluded from registration under the Investment Company Act of 1940 under Section 3c1
Investments could be redeemed only once a month
The funds were sold through an adviser
The funds were not registered under the Securities Act of 1933 or any state securities commission
The funds were under Private Placement Exemption from the registration requirements of the Securities Act, Regulation D
The investor had to be accredited
The funds were blind pools exempt from reporting requirements under the Securities Exchange Act of 1934.

As long as there is no legal definition of hedge fund, sellers are free to deny that their offerings are hedge funds, leaving investors without basic information for making informed decisions about their own assets. The population most at risk for exploitation is senior citizens, especially new retirees. When this class of investors roll over their 401Ks and take their pensions, they may have just enough money to be accredited and become hedge fund targets. This population is vulnerable with no way to recover financially in old age from risky investments. Therefore, it is a true public service to label hedge funds. Proper labeling has long been the norm in other government regulated industries: nutrition labels on food, health warnings on tobacco and alcohol. Labeling hedge funds as Private Funds is an excellent first step toward protecting retiree assets.

Public Disclosure of Private Placement Memos

Even more effective than amending the form ADV to identify hedge fund advisers would be to require these advisers to publicly disclose Private Placement Memos by filing them as part of Rule 506 Regulation D.

Private Placement Memos provide tremendously valuable information that every investor should have a right to review before hedge funds are purchased, even in the case of a securities power of attorney for the adviser. We learned from Private Placement Memos that the risks of my family members investments were substantial and inappropriate for her retirement IRA:

Forfeiture of the right to ownership of her funds accounts not held in nominee name
Isolation of her assets away from government oversight forfeiture of her right to be invested in regulated securities
Limited right to liquidate
No public market to trade, no stock exchange where the investments were recognized
No independent evaluation of the dollar value of the funds
Risk of NAV arbitrage by those administering the fund stale, month-old NAV at sale
Probable absence of errors and omissions insurance on these alternative investments
Probable absence of SIPC protection since the LLC and not my family member was the client

At every step of the way, the advisory process failed my family member: notification that the investments would be limited partnerships was omitted during the sales cycle conversion of assets appears to have taken place the fiduciary duty of the adviser was grossly breached. Even documents that my family member should have been required to sign before the hedge funds were purchased were not presented to her. It was the Private Placement Memos that revealed that she should have been required to submit a subscription agreement along with an investor questionnaire and an operating agreement. These agreements seem never to have been offered by my family members adviser. Without these Private Placement Memos, my family member would not have been able to recognize the risk or take timely action to recover her assets.

One of the most effective steps the SEC can take to prevent hedge fund exploitation of retirees is to make Private Placement Memos available to investors through public disclosure forms such as those of Rule 506 Regulation D. Disclosure gives the investor a chance to educate herself BEFORE investing takes place and a lockup period begins. The memos do not have to list all underlying securities in order to effectively educate the investor about the structure of the investment, which carries its own risks that should be disclosed.

Clarifying Acceptable Terms of Custody for Hedge Fund Advisers

Rule 2064-2 as written today allows an adviser to hold an investors securities with a qualified custodian in his own name. In a hedge fund, this means that the only record of the investors cash deposits, investments, and their value is now held by the adviser in an account that can only be accessed by or through that same adviser. In such an environment, self-dealing and theft become very real risks to the investor.

My family member was told that a large, well-known firm would custody her assets, and she filled out applications for accounts with that custodial firm. So you may imagine how alarmed we were when, after requested deposit receipts were repeatedly not delivered by the adviser, we learned by calling the custodial firm directly that they had never heard of my family member and could not trace her to any monies at their firm by tax id, name, address or date of deposit. Even though account reports were mailed to my family member from this custodial firm, as the law requires, the account numbers on those reports werent recognized by the qualified custodian they were arbitrary numbers assigned by the adviser and redeemable only at his level. Based on the rule as written, our advisor could call his firms gatekeeping behavior legal, but I think of it as self-dealing. This adviser took away from my family member the ability to access her own money independently of his firm he imposed his firm as a gatekeeper without her consent and he also took away any record of her money except through his firms own reporting, exposing her to additional risk. And as we know, his firm would later isolate her further through purchases of their house brand of hedge funds, so that she had limited rights to access and liquidate her investments, even within the advisers account.

In addition to self-dealing, conversion of assets can easily take place under the existing rules statement that the adviser can hold accounts in his name on behalf of the client. My family member wrote no checks to the adviser that might have implicitly justified substituting his firms acceptance of a deposit for that of the custodian she expected to have a personal, independent account with. In addition, the advisory firm wired some of my family members monies directly from her bank account to the custodian FBO for the benefit of the investment house instead of FBO my family member. This also appears to us to be a conversion of assets.

The SEC can protect individual investors by preventing hedge fund advisers from conversion of assets and self-dealing. The SEC can do this by strengthening the custody rule 2064-2. An investor should have the absolute right to have her cash held at a qualified custodian in her own name, and not commingled within an advisory account, especially before the hedge fund investment has been agreed to or made. Until she agrees to commingling, commingling should be outlawed. It is not enough for an audit to be sent to the investor 120, 150, or 180 days after the conversion of assets has taken place. The number of days after the fact that the audit shows up is irrelevant. By the time the audit shows up, the assets have long been converted out of the investors name and her rights have long been violated.

Closing

Our family member who inadvertently became involved with hedge funds is a widowed, retired homemaker with no marketable job skills, no investment experience, a total reliance on investment income for almost every expense for the rest of her life, and no way to recover if her assets are misused. My family members adviser is a CFA and a member of AIMR, sophisticated enough to understand his ethical duties to his client in a situation involving conflict of interest and risk. If a paid investment adviser is so willing to overlook his clients risk tolerance to bring another customer into his companys hedge funds, then who is the advocate for investors such as this retired homemaker? Not the adviser. Nor, apparently, his small firm, which is run by the former dean of one of the top business schools in the nation and former vice-chairman of the board of one of the 10 largest companies in America as ranked on the Fortune 500. It is because of this kind of complete breakdown of ethics that greater SEC oversight of the hedge fund industry is so critically needed.

Senior citizens in particular are a vulnerable population who require the protection of the SEC in the area of hedge funds, because at retirement they are more likely to have sufficient assets to be accredited and therefore be the target of hedge funds and because a single misstep with an unscrupulous hedge fund can cost them their life savings. Thank you for giving us the opportunity to submit comments to the Commission on this important question.