Hedge Fund Regulation and Misreported Returns


  • We owe thanks to two anonymous referees, Michael Hutchinson, Sofia Johan, Mark Kamstra, Nadia Massoud and the seminar participants at Queen's University, York University, the EFM Symposium on Risk Management at the Audencia School of Management (Nantes 2009), the EFMA Annual Conference at Bocconi University (Milan 2009), and the Financial Management Association (New York 2010).


This paper introduces a cross-country law and finance analysis of the misreporting behaviour in the hedge fund industry in terms of smoothing returns so that a fund consistently generates positive returns. We find strong evidence that international differences in hedge fund regulation are significantly associated with the propensity of fund managers to misreport monthly returns. We find a positive association between wrappers and misreporting, particularly for funds that do not have a lockup provision. Also, we find some evidence that misreporting is less common among funds in jurisdictions with minimum capitalisation requirements and restrictions on the location of key service providers. We assess the robustness of our finds to a number of specifications, including, different specifications of misreporting bin widths, subsets of the data by fund type, as well as specifications controlling for collinearity and selection effects and other robustness checks. We show misreporting significantly affects capital allocation, and calculate the wealth transfer effects of misreporting and relate this wealth transfer to differences in hedge fund regulation.