September 15, 2004
I respectfully submit my opposition to the proposed rule requiring certain hedge fund managers to register under the Investment Advisers Act of 1940. I am encouraged by the dissent of commissioners Cynthia A. Glassman and Paul S. Atkins, http://www.sec.gov/rules/proposed/ia-2266.htm#dissent, and the positions of the Chairman of the Federal Reserve, the Secretary of the Treasury and the Chairman of the CFTC.
Though protecting investors from being duped by unscrupulous managers is a worthy objective, it is doubtful at best that the SEC is able to provide such protection to any large extent, in my opinion. There is much less doubt, however, that further regulation of the hedge fund industry, in the form of mandatory registration or otherwise, will result in an additional cost born by Americans:
1 The direct cost of the process of registration, which hedge funds will bear in part, but also pass on to their clients in the form of higher or additional fees. In addition to wealthy individuals, some of these clients are pension funds, labor unions and charitable foundations, all three representing ordinary or underprivileged Americans.
2 The direct cost of the increased resources the SEC will need to administer the registration, which will either be born by tax-payers or again by hedge fund clients in the same way as above, if hedge funds are taxed more to recover this cost.
3 The hidden cost in the form of reduced competitiveness of American hedge funds versus those based abroad in places like Europe and the Caribbean, resulting in a loss of business to those regions. This includes the cost of US-based hedge funds relocating overseas. This cost will be born by US-based investors with a smaller choice of hedge funds to invest in and those hedge fund employees who lose their jobs if their employer ceases or relocates. The people hurt most will not be the small group of wealthy hedge fund managers but the larger group of support staff, such as accountants, human resources, IT, secretaries, receptionists, administrative personnel, cleaners, mailroom people, maintenance, cafeteria staff, security, etc. etc.
4 The hidden cost of reduced innovation within the hedge fund industry, resulting from an allocation of resources towards dealing with red tape, away from research and development. This will likely result in lower performance than would be possible otherwise, again negatively impacting hedge fund clients.
On the flip-side, as stated above, I find it doubtful at best that increased regulation will actually benefit anyone, other than the extra personnel the SEC would need to hire to administer the additional oversight and the extra lawyers hedge funds would have to hire to advise on compliance with the proposed regulation. If the past provides any guidance for what may be expected in the future, added regulation of the hedge fund industry will not likely result in better protection of investors. For instance, with all its red tape and reporting requirements, was the SEC able to protect those who invested in Enron, Global Crossing or WorldCom? Has the SEC been able to protect individual investors from high fees and mediocre returns, as compared to their benchmark indices, produced by the heavily regulated mutual fund industry?
The hedge fund industry is already regulated by government in the sense that the overwhelming majority of individual Americans are legally barred from investing in hedge funds. Besides some large institutional investors, only a small elite class of people, wealthy enough to be deemed competent in evaluating the risk and reward of investing directly in hedge funds, are allowed to do so. Is it reasonable to expect that the SEC will provide much added value to the judgments of this small group of highly competent and savvy investors? As an aside, if it is disputed that the wealth of an individual is an appropriate measure of his or her investment acumen, why does the law give them preferential treatment by allowing only them to invest in hedge funds, while excluding all other individuals?
The hedge fund industry also already regulates itself through a voluntary registration system, which allows both managers and investors to select the level of regulatory oversight, and its associated costs, that suits their particular business model and risk preferences.
In their dissent, commissioners Cynthia A. Glassman and Paul S. Atkins point to the 2003 Hedge Fund Report. This report states that there is no evidence indicating that hedge funds or their advisers engage disproportionately in fraudulent activity. This is a further indication that regulating hedge funds more will not protect their investors better. Contrary to the cost, the benefit of the proposed increased regulation in the form of mandatory registration of hedge funds under the Investment Advisers Act of 1940 is poorly understood and unlikely to be great.