Proprietary desk traders who start their own hedge funds, forced to leave banks by January 1, 2013, when the Volcker Rule goes into effect, are suddenly being thrust into managing a business and its operations as they come face-to-face with Dodd-Frank Act regulations.

“What’s happening now mirrors what happened with star traders with winning strategies ten to 15 years ago when money, ego and opportunity motivated them to leave to start hedge funds,” says Matt Simon, senior analyst at the TABB Group. “Only now they’re being thrown out of larger banks, continuing on as stand-alone hedge funds.”

The industry has changed since then, when the old saw had it that all that was needed to start a fund was two guys and a Bloomberg terminal.

Today there are more regulations to comply with and operating requirements to meet, yet former prop traders will no longer be able to depend on the requisite tools and services they had available at their former employers.

“It’s easy to underestimate all the facets that the bank had taken into account and now they need to recreate,” says Bob Guilbert, managing director at Eze Castle Integration in Boston, which provides IT systems to about 600 hedge funds worldwide. “It’s a shocker; it’s cold water in the face.”

For starters, former prop desk traders will need to register with the Securities and Exchange Commission (SEC) when they have at least $150 million in assets under management. Ten years ago they could start a fund with just a strategy, but today Dodd-Frank makes regulatory compliance one of the top priorities. 

Then there are the sophisticated operating systems, including voice and data networks and a recovery site, that hedge funds need to compete in today’s wired world. The systems must be resilient and redundant to minimize downtime, and this costs money. So does the security that goes with all of that.

In addition, hedge funds today must have institutional-quality auditors, administrators, execution partners, attorneys and insurance brokers, plus two or three prime brokers, whereas lower-level service providers and a single broker would do before.

“We know that for the real money, funds have to dress themselves up,” explains Jason Gerlach, California Hedge Fund Association (CHFA) president-elect and COO at Sunrise Capital Partners in San Diego. “Any hedge fund today has to have a real office — you can’t garage or home office it. Investors are going to come and look at your back office. They want to touch it; they want to see the people who work at your firm. They want to see how you execute a trade, how you back up your data.”