Hedge fund managers will face a new restriction when the Security and Exchange Commission’s anti-fraud rule goes into effect on September 10, against a backdrop of spectacular failures in the $1.5 trillion (€1.1 trillion) industry.  The five SEC commissioners in July voted unanimously to adopt a new rule clarifying hedge fund fraud. It prohibits advisers to investors in hedge funds as well as pooled investor vehicles from making false or misleading statements to investors or defrauding investors and prospective investors.

The rule stems from a 2005 case before the US Court of Appeals brought by Phillip Goldstein, head of Opportunity Partners, a New York-based hedge fund. He successfully overturned the SEC's registration requirement passed in 2004 by protesting that it would lead to hedge funds being saddled with additional compliance costs.

At the time, the SEC argued that the rapid growth of hedge funds in recent years combined with the rising interest of retail investors and a growing number of fraud cases in the industry justified the registration requirement.  The rule seeks to reinforce the authority of the Investment Advisers Act of 1940 governing cases where investors in a pool are defrauded by an adviser, which was undermined by the 2005 decision.

The SEC proposed the new rule to clarify its authority over account statements for investors, as well as private placement memos, offering circulars or responses to proposal requests for prospective investors.  The rule did not get published in the federal register until August 11, which means it does not go into effect until 30 days later.

Grant Esposito, a partner in the New York office of law firm Morrison & Foerster, focuses on complex commercial litigation issues. He said the new rule will probably lead hedge funds to seek more advice surrounding the valuation of underlying assets in their disclosures.

Esposito said: "I think some funds do their best, but do they do enough? It's tough to say."  The new regulation follows a series of dramatic exits and lawsuits in the hedge fund industry.

Hedge funds have come under renewed scrutiny in recent months punctuated by the high-profile collapse of Bear Stearns' two leveraged hedge funds which filed for bankruptcy protection last month as clients sue to reclaim their investments.

The SEC sought fraud charges against Sentinel Management, which recently filed for chapter 11 bankruptcy. The regulator alleges the money manager defrauded its customers when it co-mingled, misappropriated and leveraged their securities in violation of the Investment Advisers Act of 1940.

The complaint also alleges that Sentinel used securities from client accounts as collateral to obtain a $321m line of credit as well as additional leveraged financing