With the Securities and Exchange Commission’s 3-2 vote to implement registration for hedge fund’s, the cost to launch one of the hottest investment vehicles in the capital markets just became more expensive.

The two Democratic commissioners voted for the measure and two Republicans were opposed – with SEC Commissioner James Donaldson, the third Republican, providing the tiebreaking vote for the measure. The move was widely opposed within the $866 billion hedge fund industry.

The decision will take affect in February 2006.

The ruling calls for hedge funds with more than $25 million in assets to register under the Investment Company Act of 1940 as investment advisors. This will require these funds to maintain a compliance manual, provide an annual list of clients to the SEC, and allows the SEC to conduct inspections of its books.

The measure was bitterly fought by the hedge fund industry’s lobbying group, the Managed Funds Association, which views the regulation as the beginning of government encroachment in what has been the most lightly regulated area in the capital markets. A last-minute compromise deal, brokered by the MFA and several law firms with large hedge fund practices, that would have accepted some form of federal oversight in return for delaying yesterday’s vote, was rejected by the SEC. After the vote, the MFA president, Jack Gaine, said, “Nearly three out of four commentors on the proposed regulation opposed it. It remains our opinion that the case for the SEC’s proposal was not made.”

Hedge funds – managed pools of investment capital from institutions and the rich – bet on the direction of asset or securities prices using an array of strategies, and, unlike mutual funds, do not have to disclose their holdings to the general public.

Mr. Donaldson, who championed the regulation when it was proposed last September, has repeatedly invoked the rapid growth of the hedge fund industry’s assets – which stood at under $100 billion in 1994 -as one of the reasons for the push for registration. In his opening remarks yesterday prior to the Commission’s vote, he also cited the near collapse of the Long Term Capital Management hedge fund in 1998 as an example of the potential threat to the American financial system when regulatory authorities have no ability to track hedge funds.

One of the clear winners in the battle are hedge fund lawyers. A partner at a law firm with 75 hedge fund clients, Bryan Cave LLP’s Michael Mavrides, said he was certain that the increased regulatory burden on smaller funds would make for extra work for his firm.

“They are looking at thousands of dollars in extra fees to comply,” he said. Mr. Mavrides, who said most of his clients aren’t registered as investment advisers, said his firm charges about $30,000 in start-up legal fees to launch a fund. He said that might increase by as much as half, not including the cost of a full-time compliance officer – which Wall Street executives say will cost at least $100,000 annually.

Though the measure was widely opposed in the industry, some hedge fund managers claim the measure will have a negligible effect on their business because they already comply. For example, a founder and principal of T2 Partners, Whitney Tilson, said his$100 million fund – along with many other funds – has voluntarily taken the initiative to register as investment advisers. Mr. Tilson said the rules are more “annoyance” than “angst causing.” To illustrate this point, he provided to The New York Sun a copy of the dozens of rules and regulations that his fund’s attorney’s demand for compliance. These include saving all e-mail for seven years and copies of all trades made for the fund for five years.

“They are doing this to keep tabs on the risk imposed by the massive multibillion dollar funds, and as long as it doesn’t impede what I do, I can live with it,” he said.