Additional regulatory scrutiny should ultimately benefit the hedge fund industry by increasing the focus on compliance and fund governance, says Moody’s Investors Service.

In a new report, Moody’s says that regulatory scrutiny has expanded and focused more closely on alternative asset managers, particularly hedge funds, since the Madoff fraud was uncovered in December 2008.

“The passing of the Dodd-Frank Act in July 2010 marked a turning point for hedge fund governance,” says analyst and author of the report, Courtenay Sturdivant. The new law requires large hedge funds to register with the U.S. Securities Exchange Commission and subjects them to greater regulatory oversight. Funds with more than $150 million in assets under management are required to register with the SEC by March, it notes.

Moreover, Moody’s notes that hedge funds are facing more enforcement action. It reports that the investment adviser/investment company category, in which hedge funds are classified, has seen the biggest increase in enforcement actions by the SEC over the past 10 years.

“While the increase in enforcement actions may be partly attributable to the larger number of hedge funds registered with the SEC, in the past few years regulators have enhanced their means of detecting and monitoring regulatory infractions, including those related to insider trading,” Sturdivant says. And with an additional 700 private investment advisers expected to register with the commission before the end of the first quarter this year, the number of insider trading enforcement actions and inquiries is expected to rise, it adds.

Moody’s notes that concerns about the potential for insider trading relates mainly to hedge funds’ large trading volumes and their propensity to use electronic trading platforms. Sturdivant also points to the strong relationship between hedge funds and brokerage firms, with a large number of hedge fund managers previously employed at investment banks, as well as the relative immaturity of the hedge fund industry in terms of operational controls and compliance.

“Additional regulatory scrutiny should ultimately work to the benefit of the hedge fund industry,” Sturdivant says. “While initially it will increase the related operational costs, it should reduce funds’ business risk in the long term, and improve operational infrastructure, internal compliance and transparency, all to the benefit of investors.”