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MFA Submits Last Pitch Against Hedge Fund Adviser Registration

The SEC has scheduled a vote for next Tuesday on whether to adopt rules to require hedge fund advisers to register under the Investment Advisers Act. The proposal was opposed by both Commissioners Cynthia Glassman and Paul Atkins. The Managed Funds Association recently submitted a summary of comments letter to the SEC reporting that 73% of the commenters opposed the proposal and many of them submitted alternatives to the SEC's proposal. In light of the division among the commissioners, the lack of support by the President's Working Group on Financial Markets and the lack of a public policy case to support the proposed rule, MFA said the SEC should at least consider the alternatives before proceeding with its proposal.

MFA reported that 156 letters were submitted in response to the SEC's hedge fund proposal. Many of the letters in opposition to the proposal provided strong reasons for not adopting the registration requirement, according to MFA, while those who favored the proposal tended to be brief and to rely on anecdotal information. MFA also pointed out that the chief proponent of the proposal is a trade association that represents the mutual fund industry, which is a competitor of the hedge fund industry.

MFA said that it does not necessarily support any of the alternative proposals that were submitted for SEC consideration, but believes that the SEC should at least entertain the possibility of an alternative. The alternative proposals could serve as a starting point in the effort to find a balance between the SEC's wish to obtain comprehensive information about the hedge fund industry without subjecting a successful industry to unnecessary regulation.

MFA summarized the arguments for and against the SEC's proposal. Among the arguments against it is its questionable legal authority to take such action. Some believe that an appropriate regulatory framework already exists through the antifraud and antimanipulation provisions of the Investment Advisers Act. One of the concerns expressed by SEC Chairman William Donaldson is the retailization of hedge funds, but opponents to the proposal, including the dissenting commissioners, maintain that there is no evidence to support that concern. Funds of hedge funds that are offered to the public are already registered with the SEC, according to opponents.

Another concern of opponents is that mandatory registration would require enormous SEC resources for a relatively small number of wealthy investors. Others said that registration may impede the entrepreneurial efforts that have created the diverse and innovative funds.

MFA also summarized the recommended alternatives to the SEC, which included a proposal to require annual audits by independent accounting firms and the distribution of audited annual financial statements and unaudited quarterly financial statements to investors.

Supporters of the proposal have suggested that the registration requirement would help the SEC to detect fraud, but MFA noted that the SEC did not deter or prevent the fraud in the highly regulated mutual fund industry that was uncovered in 2003. MFA also noted that the 46 enforcement cases brought against hedge funds in the past five years typically involved an adviser that was too small to be subject to the SEC's proposal, one that was already registered with the SEC or one that evaded SEC regulations.

In closing, MFA quoted a remark by Federal Reserve Board Chairman Alan Greenspan suggesting that if hedge fund adviser registration fails to meet its objectives, the SEC may not be able to resist an expansion of its regulatory reach from hedge fund advisers to hedge funds themselves.