Hedge funds, nervously awaiting next year's industry regulations, will get a taste of the rule next month when they must prove their clients really are rich if they want to earn a fee for managing other people's money. The loosely regulated $1 trillion hedge fund industry traditionally catered to wealthy individuals and long operated out of regulators' sight, avoiding the routine audits that traditional asset managers face every year.

After Main Street investors, however, began to demand access to these often successful but sometimes risky investment vehicles, the US Securities and Exchange Commission voted last year to force nearly all hedge funds to register by next February.

One part of the new rule will become effective much sooner, though.

Starting on March 1, regulators will make sure that only so-called "qualified investors" will be allowed into a fund - if the manager wants to collect the typically high performance fees that attract so many of them to the industry.

"It is a modification and it ties into the new hedge fund adviser rule," said David Hearth, a partner at law firm Paul, Hastings, Janofsky & Walker LLP.

Soon, hedge fund managers will have to take at least a $750,000 investment from their clients or prove they are worth at least $1.5 million in order to charge them the 20 percent incentive fee that most of the roughly 7,000 funds demand.

Until now, fund managers who wanted to court retail customers had ways to invite in the less affluent.

There was a provision that let managers have so-called family and friends in their funds and some managers quietly ratcheted their minimum investments down sharply to $25,000, far below the $1 million many of the most successful funds require.

"This will raise the bar slightly for hedge funds, but it has been in place for other investment managers for some time," said George Mazin, a partner at law firm Dechert LLP.

Some fund managers are already rethinking their strategies.

"My sister, who is a teacher, wanted into my fund and that just isn't going to happen now," said a Boston-based manager in the process of starting up a new fund. He spoke on condition that he not be named.

Lawyers generally agree this first part of the new rule won't change life substantially in the fast-growing industry.

"It is not that big of a deal," Hearth said.

Fund managers can still choose to waive the performance fee for those who don't qualify - allowing, for example, junior employees in the firm who have just graduated from college to invest in a hedge fund after all.

"Many funds charge only a management fee to select clients and they can continue to do that," Dechert's Mazin said.

Copyright Reuters, 2005