In a recent Feb 26th Bloomberg article titled ‘Hedge-Fund Assets Offshore Exempt from Reporting Rule’, the Internal Revenue Service said “with respect to accounts for calendar year 2009 and earlier, U.S. investors don’t have to report large holdings (exceeding $10,000) in offshore hedge funds and private-equity firms this year under disclosure rules designed to detect offshore tax evasion and money laundering.”

This decision seems like a win for US Investors investing in Offshore Hedge Funds.  It allows the Investors to avoid the June 30th filing deadline that the Financial Crimes Enforcement Network (FinCEN) put forward and seems to allow the investors to completely avoid the penalties of having unreported Offshore accounts from 2009 and years prior.

Most Financial Institutions require all employees/consultants to undergo yearly Money Laundering courses; yet this IRS decision seems in direct violation of the Money Laundering courses designed to keep the Financial Industry honest and healthy.

Questions arise on this decision:  Is this decision just for this year as a means to extend the June 30th deadline? Or, is this a complete forgiveness for past Money Laundering transgressions?  Which is better?

It would set a powerful precedence in the financial industry allowing other financial institutions to break loosely defined rules, like Money Laundering, and then not to pay any penalty and be forgiven one day, seemingly allowing dishonest financial practices without any penance.

Money Laundering does not usually hurt the Financial Institution that commits this act; instead it hurts other Financial Industries, US Interests, US Security and the Health of the overall US economy. Hopefully FinCEN will reassess this decision and will extend the deadline to a date past this year allowing individuals who have unknowingly committed Money Laundering to come forth and avoid the costly penalties and fees that may exceed their investments.  This will allow US Investors to follow a clearly defined set of rules put forth by the IRS and to have confidence in the Hedge Fund that they are investing in.

If FinCEN allows this decision to stand and by not extending the deadline to a date past this year, it will most likely have profoundly negative effects on the Hedge Fund Markets view of regulation and the regulatory authorities.  It would seem to weaken the Industry regulators by setting a precedent of allowing Financial Institutions to ignore loosely defined rules and endorse illegal investments, thereby weakening the IRS’s stand on enforcing/abiding by their own rules. Ultimately the cost may be that the US Investor will not be able to discern the important rules from the un-important rules causing them to possibly lose money or Assets in unsafe or illegal investments.

It may seem counterintuitive, but we believe that the best regulatory environment for the hedge funds is one where the regulators are strong, well informed and work from a consistent set of rules, and level of enforcement. Without the presence of a strong group of well run regulators, the Hedge Fund Marketplace will continue to be dogged by the Madoff  effect. By that we mean that Hedge Funds will be devastated each time some scandal occurs in the industry, shaking Investor’s confidence in the Hedge Fund Market and seeing quick and large moves of money out of the industry.

At the end of the day, the Hedge Funds and the Investors rely on the markets and the regulators ability to determine a proper risk weighting on all Investments. For that reason we believe the IRS owes it to the Industry to ensure that this rule is defined clearly and proper time is allowed for members of the industry to receive forgiveness for unintentional violations.

We look forward to the IRS final decision on this decision and the effects on the Hedge Fund Market Industry.

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