Has Hedge Fund Regulation Hit a Wall?
March 16, 2009
The hedge fund industry has largely accepted regulation as inevitable, and legislators have called it a priority, but despite the apparent momentum, there is little to indicate that federal oversight will become a reality anytime soon.
Prompted by risk concerns highlighted by scandals and the financial crisis, Congress has introduced several bills addressing hedge funds. While the two main measures each take different approaches, neither is given much chance without key players signing on. Yet to make their positions clear are Christopher Dodd, chairman of the Senate Finance Committee, and House Financial Services Committee chairman Barney Frank, who may do so by introducing bills of their own.
Meanwhile, state legislators are attempting to step into the breach. In Connecticut, three bills were introduced in January, each with a specific--if narrow--focus. One bill would require hedge funds to obtain a license, and another would mandate greater disclosure; a third seeks to restrict investors to individuals with more than $2.5 million in assets and institutions with over $5 million.
According to Monica Arora, a partner in law firm White & Case's investment funds group in New York, the Connecticut bills are a "patchwork" attempt to address issues that are being dealt with more comprehensively by two federal bills--the Hedge Fund Transparency Act in the Senate, and the Hedge Fund Adviser Registration Act in the House.
Focus on the Fund
The former, introduced by Senators Charles Grassley, R-Iowa, and Carl Levin, D-Mich., is a departure from previous attempts to regulate hedge funds because it focuses on the fund rather than the adviser to the fund. It would require hedge funds with more than $50 million in assets to register under the Investment Company Act of 1940, provided that they meet certain requirements. Funds also would have to supply the Securities and Exchange Commission with information such as the identity of the fund's beneficial owners. All private funds, regardless of asset size, would be subject to certain anti-money-laundering requirements.
While hedge funds are the bill's primary target, it covers venture capital and other private equity finds, as well as special-purpose structured financial entities.
The rationale for looking at the fund rather than the adviser goes back to problems that surfaced around the time of the New Deal, when abuses were uncovered by mutual fund boards, according to Anita Krug, a partner in San Francisco-based law firm Howard Rice Nemerovski Canaday Falk & Rabkin. The Investment Company Act, which contains a broad array of investor protections, was intended to eliminate those abuses.
In the case of the hedge fund industry, the shift in focus may stem from the heightened concern among regulators about the systemic risk created by large funds, says Krug. With the financial markets becoming increasingly complex, counterparties and creditors need to know more about hedge funds' positions and concentrations, and the degree of leverage embodied in them.
While the Senate bill would bring hedge funds under the Investment Company Act, it would exempt them from the full panoply of requirements that mutual funds face. For example, hedge fund managers themselves would not need to register with the SEC.
The Investment Advisers Act of 1940, by contrast, addresses investment management professionals. "It was not as clear cut that the Investment Advisers Act was necessary," says Krug. Nevertheless, prior attempts to regulate hedge funds have centered on the adviser, and the act is the basis of the House's latest hedge fund oversight effort, a bill introduced in late January by Reps. Michael Capuano, D-Mass., and Michael Castle, R-Del.
