Hedge Fund Regulation: It’s going to take an act of Congress
Recent events have made it clear that hedge funds pose systemic risk to the financial industry, individual investors and the general public. A rash of hedge fund blow-ups and frauds show that self-regulatory and market-discipline principles aren’t effective. Left unchecked, hedge funds will continue to damage the markets. In January 2009 Senators Levin and Grassley introduced The Hedge Fund Transparency Act which would close a loophole left open by the Investment Company Act of 1940 that allowed hedge funds to evade the definition of an “investment company”. Congress should adopt this bill or something very similar. Otherwise, hedge funds will continue to abuse the shortfalls of our regulatory system.
This is why I’m looking forward to tomorrow’s Senate Banking Committee Hearing entitled “Investor Protection and the Regulation of Securities Markets.” Hedge fund regulation ought to take center stage.
Hedge funds, by far, have more capital in the equities market then any other asset class. Their transactions are often so large that the impact in the broader markets can be and is quite impactful. Therefore the risks they take are not only their own. That’s why reform needs to start with registration. Under former SEC Chairman Christopher Cox, the SEC’s attempt at hedge fund registration requirements was thwarted by the aforementioned loophole. Naturally, Mr. Cox chose to drop the issue altogether rather then lobby Congress for change.
If investment advisors are required to register, hedge fund managers should be as well, no matter how many “official” clients they have. Regulators can and should periodically audit firms to ensure risk isn’t out of control. Risk disclosures must be more transparent. Enough is enough with the creative micro-text found at the end of an offering memorandum.
Once hedge funds fall under regulatory authority, enforcement of the law is paramount. Unfortunately, the SEC has fallen short of enforcing Wall Street effectively even though those institutions fall under their regulatory authority. This must change for Wall Street and hedge funds alike. The punishment must fit the crime and investors should have a clear and fair process to challenge any perceived wrongdoing.
Thus, investors and employees of hedge funds should be able to file arbitration claims against hedge funds. Arbitration claims, though not perfect, are more cost efficient than litigation and are heard in a much shorter period of time.
Hedge fund regulation is clearly vital to any future functioning financial system in this country but it can’t end there. There also must be more scrutiny given to the esoteric derivatives market like credit default swaps. Look no further than AIG to see the problems this largely unregulated market has created. Just this week, Chairman Ben Bernanke called AIG “a hedge fund basically” that “exploited a huge gap in the regulatory system”.
If AIG, a public, “regulated” company can operate “like a hedge fund” due to regulatory gaps, then reform is clearly way past due. I trust that Congress will do the right thing and enact legislation that will close regulatory loop holes, protect investors and strengthen our financial system in the process.