Comments for the
U.S. Securities and Exchange Commission
Roundtable on Hedge Funds
May 14-15, 2003
David A. Vaughan
Partner, Dechert LLP
"Hedge fund" is an expression believed to have been first applied in 1949 to a fund managed by Alfred Winslow Jones.1 Mr. Jones's private investment fund combined both long and short equity positions to "hedge" the portfolio's exposure to movements in the market. Today, hedge funds are no longer defined by a particular strategy and often do not "hedge" in the economic sense. The following is a selection of definitions and descriptions of the term "hedge fund" showing the diversity of views among commentators.
"The term 'hedge fund' is commonly used to describe a variety of different types of investment vehicles that share some common characteristics. Although it is not statutorily defined, the term encompasses any pooled investment vehicle that is privately organized, administered by professional money managers, and not widely available to the public."
--THE PRESIDENT'S WORKING GROUP ON FINANCIAL MARKETS, HEDGE FUNDS, LEVERAGE, AND THE LESSONS OF LONG-TERM CAPITAL MANAGEMENT 1 (1999).
"The term 'hedge fund' refers generally to a privately offered investment vehicle that pools the contributions of its investors in order to invest in a variety of asset classes, such as securities, futures contracts, options, bonds, and currencies."
--THE SECRETARY OF THE TREASURY, THE BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM, THE SECURITIES AND EXCHANGE COMMISSION, A REPORT TO CONGRESS IN ACCORDANCE WITH § 356(c) OF THE USA PATRIOT ACT OF 2001 (2002).
"Hedge funds engage in a variety of investment activities. They cater to sophisticated investors and are not subject to the regulations that apply to mutual funds geared toward the general public. Fund managers are compensated on the basis of performance rather than as a fixed percentage of assets. 'Performance funds' would be a more accurate description."
--GEORGE SOROS, OPEN SOCIETY: REFORMING GLOBAL CAPITALISM 32 n.† (2000).
"A hedge fund can be broadly defined as a privately offered fund that is administered by a professional investment management firm (or 'hedge fund manager'). The word 'hedge' refers to a hedge fund's ability to hedge the value of the assets it holds (e.g., through the use of options or the simultaneous use of long positions and short sales). However, some hedge funds engage only in 'buy and hold' strategies or other strategies that do not involve hedging in the traditional sense. In fact, the term 'hedge fund' is used to refer to funds engaging in over 25 different types of investment strategies .…"
--MANAGED FUNDS ASSOCIATION, HEDGE FUND FAQs 1 (2003).
"A hedge fund is an actively managed investment fund that seeks attractive absolute return. In pursuit of their absolute return objective, hedge funds use a wide variety of investment strategies and tools. Hedge funds are designed for a small number of large investors, and the manager of the fund receives a percentage of the profits earned by the fund. Hedge fund managers are active managers seeking absolute return."
--ROBERT A. JAEGER, ALL ABOUT HEDGE FUNDS, at x (2003) (Perhaps in a bit of his own hedging, Jaeger calls his definition "provisional.").
"There is no universally accepted meaning of the expression 'hedge fund'; indeed, many competing (and sometimes partially contradicting) definitions exist. The term first came into use in the 1950s to describe any investment fund that used incentive fees, short-selling, and leverage. A summary definition frequently used in official sector reports is 'any pooled investment vehicle that is privately organised, administered by professional investment managers, and not widely available to the public'. The term can also be defined by considering the characteristics most commonly associated with hedge funds. Usually, hedge funds:
--FINANCIAL SERVICES AUTHORITY (UNITED KINGDOM), HEDGE FUNDS AND THE FSA, DISCUSSION PAPER 16, at 8 (2002).
"The term 'hedge fund' is used to describe a wide variety of institutional investors employing a diverse set of investment strategies. Although there is no formal definition of 'hedge fund,' hedge funds are largely defined by what they are not and by the regulations to which they are not subject. As a general matter, the term 'hedge fund' refers to unregistered, private investment partnerships for wealthy sophisticated investors (both natural persons and institutions) that use some form of leverage to carry out their investment strategies."
--BRANDON BECKER AND COLLEEN DOHERTY-MINICOZZI, HEDGE FUNDS IN GLOBAL FINANCIAL MARKETS 3 (2000).
"Originally set up to 'hedge bets' or insure against currency or interest rate risks, hedge funds have since taken on a much wider remit, investing in assets ranging from equities and fixed interest stocks to derivatives and commodities. Their aim is to make absolute returns, that is to make performance returns irrespective of which way the markets are going. Rather like derivative funds, hedge funds use derivative instruments or gearing (borrowing against the fund's assets) to gain greater exposure to their investments or to protect against losses."
--ROBERT B. MILROY, STANDARD & POOR'S GUIDE TO OFFSHORE INVESTMENT FUNDS 28 (2000).
"The term 'hedge fund' was in use as early as the 1960s to describe a new speculative investment vehicle that used sophisticated hedging and arbitrage techniques in the corporate equities market. In the late 1960s, former Securities and Exchange Commissioner Hugh Owens described 'hedge funds' as 'private investment partnerships which employ the investment techniques of leveraging and hedging.' In the 1970s and 1980s, the activities of similar types of funds broadened into a range of financial instruments and activities .… The term 'hedge fund' does not have a precise definition, but it has been used to refer generally to a cadre of private investment partnerships that are engaged in active trading and arbitrage of a range of different securities and commodities."
--DEPARTMENT OF THE TREASURY, SECURITIES AND EXCHANGE COMMISSION, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM, JOINT REPORT ON THE GOVERNMENT SECURITIES MARKET, at B-64 (1992) (citing HUGH OWENS, SECURITIES AND EXCHANGE COMMISSIONER, A REGULATOR LOOKS AT SOME UNREGULATED INVESTMENT COMPANIES: THE EXOTIC FUNDS, REMARKS BEFORE THE NORTH AMERICAN SECURITIES ADMINISTRATORS ASSOCIATION (Oct. 21, 1969)).
A hedge fund is a "private investment partnership (for U.S. investors) or an off-shore investment corporation (for non-U.S. or tax-exempt investors) in which the general partner has made a substantial personal investment, and whose offering memorandum allows for the fund to take both long and short positions, use leverage and derivatives, and investment in many markets. Hedge funds often take large risks on speculative strategies, including [program trading, selling short, swap, and arbitrage]. A fund need not employ all of these tools all of the time; it must merely have them at its disposal."
--JOHN DOWNES AND JORDAN ELLIOTT GOODMAN, BARRON'S, FINANCE & INVESTMENT HANDBOOK 358 (5th ed. 1998).
"There is no precise definition of the term 'hedge fund,' and one will not be found in the federal or state securities laws. The term was first used to describe private investment funds that combine both long and short equity positions within a single leveraged portfolio. It is generally believed that the first such fund to employ this approach was an investment partnership organized in 1949 by Alfred Winslow Jones .… Hedge funds are no longer defined by the strategy they pursue. While a number of today's funds pursue the hedged equity strategy of Jones, numerous different investment styles are embraced by hedge funds .… Hedge funds are defined more by their form of organization and manner of operation than by the substance of their financial strategies."
--Scott J. Lederman, Hedge Funds, in FINANCIAL PRODUCT FUNDAMENTALS: A GUIDE FOR LAWYERS 11-3, 11-4, 11-5 (Clifford E. Kirsch ed., 2000).
"The term 'hedge fund' is undefined, including in the federal securities laws. Indeed, there is no commonly accepted universal meaning. As hedge funds have gained stature and prominence, though, 'hedge fund' has developed into a catch-all classification for many unregistered privately managed pools of capital. These pools of capital may or may not utilize the sophisticated hedging and arbitrage strategies that traditional hedge funds employ, and many appear to engage in relatively simple equity strategies. Basically, many 'hedge funds' are not actually hedged, and the term has become a misnomer in many cases."
--WILLIAM H. DONALDSON, CHAIRMAN, SECURITIES AND EXCHANGE COMMISSION, TESTIMONY CONCERNING INVESTOR PROTECTION IMPLICATIONS OF HEDGE FUNDS BEFORE THE SENATE COMMITTEE ON BANKING, HOUSING AND URBAN AFFAIRS, Apr. 10, 2003, available at http://www.sec.gov/news/testimony/041003tswhd.htm.
"Like mutual funds, hedge funds pool investors' money and invest those funds in financial instruments in an effort to make a positive return. However, unlike mutual funds, hedge funds are not registered with the SEC. This means that hedge funds are subject to very few regulatory controls. In addition, many hedge fund managers are not required to register with the SEC and therefore are not subject to regular SEC oversight. Because of this lack of regulatory oversight, hedge funds historically have been available to accredited investors and large institutions, and have limited their investors through high investment minimums (e.g., $1 million).
Many hedge funds seek to profit in all kinds of markets by pursuing leveraging and other speculative investment practices that may increase the risk of investment loss."
--SECURITIES AND EXCHANGE COMMISSION, HEDGING YOUR BETS: A HEADS UP ON HEDGE FUNDS AND FUNDS OF HEDGE FUNDS, available at http://www.sec.gov/answers/hedge.htm.
"'Hedge fund' is a general, non-legal term used to describe private, unregistered investment pools that traditionally have been limited to sophisticated, wealthy investors. Hedge funds are not mutual funds and, as such, are not subject to the numerous regulations that apply to mutual funds for the protection of investors - including regulations requiring a certain degree of liquidity, regulations requiring that mutual fund shares be redeemable at any time, regulations protecting against conflicts of interest, regulations to assure fairness in the pricing of fund shares, disclosure regulations, regulations limiting the use of leverage, and more."
--SECURITIES AND EXCHANGE COMMISSION, INVEST WISELY: AN INTRODUCTION TO MUTUAL FUNDS, available at http://www.sec.gov/investor/pubs/inwsmf.htm.
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May 13, 2003
|1||See ROGER LOWENSTEIN, WHEN GENIUS FAILED (2000); see also Scott J. Lederman, Hedge Funds, in FINANCIAL PRODUCT FUNDAMENTALS: A GUIDE FOR LAWYERS 11-3, 11-4, 11-5 (Clifford E. Kirsch ed., 2000); Loomis, The Jones Nobody Keeps Up With, FORTUNE (Apr. 1966).|