Regulatory Oversight and Return Misreporting by Hedge Funds

We use Securities and Exchange Commission (SEC) rule changes to show that regulatory oversight reduces return misreporting by hedge funds. Specifically, we use a 2004 rule change that expanded SEC oversight of hedge funds and the 2006 revocation of this rule. Differences-in-differences tests show that, following the rule change, misreporting by newly regulated funds decreased. After revocation, funds that exited the regulatory system increased misreporting relative to funds that remained registered. Placebo tests show no change in misreporting by foreign funds exempt from the rule change. We show that regulatory oversight increased the level of flows and decreased the sensitivity of flows to underperformance.