The Securities and Exchange Commission’s inspector general says hedge funds should be forced to use independent custodians and certify that they have conducted proper due diligence.
H. David Kotz made the recommendations in a letter to Rep. Paul Kanjorski, chairman of the House of Representatives subcommittee on capital markets. According to Kotz, the custodial rule—similar to one already in place for mutual funds—would prevent Ponzi schemes.
“This custodian requirement essentially removes the ability of an investment adviser to fraudulently use the proceeds invested by new investors to make payments to old investors,” Kotz wrote to Kanjorski.
In another suggestion based on a rule already in place, Kotz said hedge fund and investment advisers should have to sign a pledge—under penalty of law—that they have conducted due diligence, much like CEOs are required to certify their companies’ financial statements.
Kotz also backed empowering the Public Company Accounting Oversight Board to audit reports prepared by accounting firms, as well as expanding the SEC’s whistle-blower incentives beyond insider-trading cases.