The current economic crisis and the international uproar over the Madoff scandal have brought with them a renewed scrutiny of the hedge fund (and to a lesser extent the broader private fund) industry, causing governments around the world to call for stricter oversight of these lightly regulated investment funds. With that backdrop, the industry is bracing itself for what now seems inevitable – that private funds and their managers will face some form of increased oversight in the near future. (For more information about possible areas of regulatory or legislative focus in the US, click here.)

There are, for example, bills in the US Congress that would impose various requirements on private investment funds and, in one case, would remove in its entirety the exception from US federal investment adviser registration for investment advisers with a limited number of clients. These bills, while purporting to focus on hedge funds, are written broadly enough to affect many other types of private investment funds, including LBO funds, venture capital funds and some real estate funds.

Hedge fund firms faced similar US registration requirements several years ago when the US Securities and Exchange Commission (SEC) proposed a rule requiring hedge fund managers to register with the agency as investment advisers under the US Investment Advisers Act of 1940. That rule was vacated by a US court in 2006 on grounds that the SEC had overstepped its authority and that action by Congress would be required to achieve the SEC's goals.

The Madoff scandal is also prompting the SEC's investment adviser inspections office to ramp up aspects of its regular inspection programs (often called "SEC examinations"). Already these examinations are including much more pointed questions about the custody of client assets. An SEC official has suggested that the agency's efforts to verify the existence of claimed assets will include direct contacts between the SEC and the custodians used to hold account assets. More controversially, they also may include "spot checks" in which the SEC examiners directly contact hedge fund investors for verification of their capital account balances.

The US is not the only country turning a watchful eye to private investment funds. At a recent meeting of representatives of the Group of Seven (G7) countries, increased regulation of the hedge fund industry made the agenda as German and French representatives pressed for increased oversight. Citing hedge funds' increasing influence on companies, Germany's Finance Minister continues to seek regulation of hedge funds and increased transparency requirements and has indicated his support for a French proposal that would seek higher capital reserve requirements for banks in the EU to reflect the risks created by hedge fund clients. The intended outcome of this proposal would be indirect regulation of the hedge fund industry through the improved transparency and internal controls that would result from increased regulation of their prime brokers. This notion of increased oversight and indirect regulation of hedge funds by monitoring the banks that lend them money – a task that some have noted will be easier than monitoring each individual investment fund manager – appears to be gaining some momentum and may be revisited at an upcoming meeting of representatives of the Group of 20 (G20) countries in London in April.

Finally, private fund regulation has been endorsed by the "Group of 30" – an international committee of current and former senior bankers and regulators. In its report published in January 2009, the group recommended a uniform international approach that would include registration of fund managers, limitations on leverage and limitations on some dealings between banks and private investment funds.