March 9, 2007
Having invested in hedge funds for more than a quarter-century, and written extensively about them, I strongly concur with the SECs goal of protecting unsophisticated investors from investing in hedge funds. However, I would argue just as strongly that the FILTER chosen to screen out unsophisticated investors is inappropriate.
The current wealth tests are arbitrary and highly discriminatory, and raising the wealth requirements would worsen an already ill-conceived test. The appropriate question is:
What is the best way to protect the public from making investments that are far riskier than they perceive?
We must first recognize the problems with the current wealth-test filters:
1) The current wealth-test filters dont screen out unsophisticated investors. Indeed, there are legions of very wealthy hedge fund investors that should have sucker tattooed on their foreheads.
2) Yet, the current wealth-test filters are enormously discriminatory against multitudes of extremely bright investors They screen out some of the most sophisticated investors in the marketplace.
So, what is the best way to protect the public from risks they didnt comprehend? The answer should rely mostly on the fundamental principles of efficient free markets.
The best FILTER for investing in hedge funds would be a combination of much lower wealth tests, and MANDATORY PRIVATE DISCLOSURE of numerous metrics, and after a time, specific holdings by hedge funds that wish to remain unregistered. This is a concept I would like to discuss in detail with the SEC.
Please recognize that no amount of regulation will protect true idiots. However, minimal regulation that better supports free market functions will protect far more investors than the current or proposed wealth-test filters.