(The article featured
below is a selection from Hedge
Funds and Private Equity: Risk Management and Regulatory Update, which is
available to subscribers of that publication.)
Legislation Requiring SEC
Registration of Hedge Fund Advisers Will be Narrowly Crafted
During House hearings
on legislation to regulate hedge fund advisers, Rep. Paul Kanjorski said
that hedge funds deserve a narrowly tailored regulatory treatment. But if hedge
funds want to "continue to swim'' in U.S. capital markets, he continued,
they must, fill out the forms and get an "annual pool pass'' in the form of
SEC registration. The Chair of the Capital Markets Subcommittee promised that
hedge fund regulation will be customized so that small firms are treated
differently than large firms by giving the SEC flexibility in implementing the
hedge fund registration legislation. In this regard, he praised the
Capuano-Castle draft legislation, HR 711, as a good bill to accomplish the goal
of registering hedge fund investment advisers.
Regulation is needed, said the Chair, because, in addition to impacting systemic
risk, hedge funds go beyond institutional and other sophisticated investors.
Hedge fund activities directly affect the fortunes of pension funds, he noted,
which indirectly affects ordinary workers, many of whom were unaware of the
risks involved until the current crisis.
The hedge fund industry recognizes that mandatory SEC registration for hedge
fund advisers is one of the key regulatory reform proposals being considered by
Congress. Richard Baker, CEO of the Managed Funds Association, testified that it
is proper to register hedge fund advisers with the SEC under the Investment
Advisers Act. He believes that the best way to do this is for Congress to remove
the current exemption from registration for advisers with fewer than fifteen
clients, which is the approach taken by HR 711.
Echoing Rep. Kanjorski, the MFA asked Congress to include in the legislation a
registration exemption for small hedge fund advisers with a de minimis
amount of assets under management. While the MFA was loath to suggest a de
minimis amount, Mr. Baker said that it should be an amount that is not so
high as to create a significant loophole that undermines a comprehensive
registration regime, and also not so low that the smallest advisers are unable
to survive because of regulatory costs. He also said that Congress should ensure
that federal legislation in this regard is consistent with state regulation of
smaller investment advisers and avoids duplication.
The MFA CEO also asked Congress not to impose regulations limiting the
investment strategies of hedge funds. Similarly, regulations on capital
requirements, use of leverage, and similar types of restrictions on the funds
should not be considered as part of a regulatory framework for private pools of
capital.
Reporting requirements required by the legislation should provide regulators
with information allowing them to fulfill their oversight responsibilities as
well as to detect and punish fraud, said the MFA CEO. But he cautioned Congress
to avoid overly broad reporting rules since such could limit the effectiveness
of a reporting regime as regulators may be unable to effectively review and
analyze data. Moreover, duplicative reporting could be costly to market
participants without providing additional benefit to regulators.
Importantly, he asked Congress to protect the confidentiality of sensitive,
proprietary information that hedge fund advisers and market participants would
be required to disclose. Public disclosure of such information could be harmful
to investors that may act on incomplete data, as well as harming the ability of
market participants to establish and exit from investment positions in an
economically viable manner.
The MFA also believes that the legislation should distinguish between different
types of investors and market participants to whom hedge funds offer their
services. Thus, Mr. Baker urged Congress to tailor the legislation to
distinguish between private sales of hedge funds to sophisticated investors
under the SEC's private placement regulations and publicly offered sales to
retail investors. He noted that this private-public, sophisticated-retail
distinction has been in existence in the United States for over 75 years and has
generally proven to be a successful framework for financial regulation.
Finally, the MFA urged that the legislation on hedge fund adviser registration
refrain from addressing the broader market issues of short selling and insider
trading, which is the approach taken in the proposed European Union legislation
regulating hedge fund advisers. These market issues are not specific to the
hedge fund industry, he emphasized, and, therefore should be dealt with in broad
market reform legislation.
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