Hedge funds are a collective investment scheme where the financial resources of an investment pool are gathered and utilized in mass for strength. The structure is similar to a mutual fund, but according to the U.S. Securities and Exchanges Commission, “Hedge funds typically issue securities in ‘private offerings’ that are not registered with the SEC under the Securities Act of 1933.”
With that in mind, the SEC is involved in prosecuting those who operate hedge funds for fraudulent purposes. One of the most infamous cases in recent memory is that of now disgraced hedge fund manager, Bernard Madoff. Madoff is guilty of running a Ponzi scheme where many investors lost money due to his fraudulent practices. However, because hedge funds are exempt from regulations in the U.S., the corruption and deceptiveness practiced by Madoff was not noticed until after many of his investors already lost millions due to his lack of ethics.
Lack of Regulation
Because of the exemption from U.S. regulation of hedge funds, investors participating in this type of investment do not receive the protection of federal and state laws that typically apply to registered investments. Hedge funds will not provide you with the same level of disclosures as other types of investments, and the SEC and other securities regulators have limited legal right to routinely check on the legitimacy of hedge fund activities.
Despite the lack of U.S. regulations on hedge funds, this type of investment instrument tends to be one of the fasting growing sectors of the financial industry. Hedge funds are a trillion dollar industry worldwide and have produced another type of investment called a “fund of fund” (a fund composed of hedge fund investments). Although many funds of funds are registered with the SEC, the core hedge funds may not be thus still providing investors with a level of risk.