Legislation Requiring SEC Registration of Hedge Fund Advisers Will be Narrowly Crafted Says House Leader

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 US 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.