The U.S. Securities and Exchange Commission (SEC) has set up a dedicated unit focused on private investment funds, including private equity and hedge funds. Increased reporting requirements for private investment managers have provided the SEC with additional data to track hedge funds and private equity funds. The SEC has also recently focused on data-driven efforts to detect potential performance reporting issues, whether in corporate accounting or investment returns.
For example, the SEC has conducted multiple enforcement actions derived from its investment performance tracking system. This system is “used to comb through the investment returns of thousands of funds and identify those whose returns are unusually high or out of line with the overall market.” Beth M. Bates & Gregory S. Rowland, “SEC Aberrational Performance Inquiry Using Data-Driven Tools to Uncover Adviser Misconduct,” Financier Worldwide, Dec. 2013. In 2011, Robert Khuzami, then director of enforcement for the SEC, indicated that “the SEC [was] canvassing all hedge funds for aberrational performance” and increasing scrutiny of funds that steadily outperform indices by 3 percent.
In this article, we provide an overview of recent economic research on potential performance manipulation by private investment managers, to shed light on statistical indicators that the SEC may use in screening for potential reporting issues. Although that research is limited to the available data and their quality, fund managers and their advisors can monitor regulatory risk by understanding the signals that regulators may be monitoring, determining whether a fund stands out on any of those metrics and, if so, understanding why it does.