A panel of government regulators, academics and industry participants told a U.S. Senate subcommittee on Tuesday that no further regulation of hedge funds is needed. The lone exception to this nearly unanimous view came from the SEC representative, Susan Wyderko, who hinted that additional regulation might be on the horizon, but only after the SEC analyzes information gathered from inspections of newly-registered hedge fund managers.
Nebraska Senator Chuck Hagel chaired the hearings entitled "Role of Hedge Funds in our Capital Markets" and questioned panelists from each of the major agencies comprising the President’s Working Group on Financial Markets. Only two senators, Mike Crapo and John Sununu, openly questioned the SEC’s authority to regulate hedge fund managers. Senator Crapo went so far as to call on the U.S. Court of Appeals for the D.C. Circuit to invalidate the SEC’s hedge fund manager registration rule, currently under review by that Court.
Although the SEC’s hedge fund manager registration rule was passed 3-2 over the strongly-worded dissent of Commissioners Atkins and Glassman (see sidebar on Glassman’s announced retirement from the SEC), few observers believe that the new rule will be overturned by the Court. Instead, most observers, including many in the hedge fund industry, fear that the SEC’s new hedge fund manager rule will, in practice, be the functional equivalent of hedge fund regulation. Those observers have a point.
What the Senate hearings failed to highlight is that simple truth that many hedge fund managers are legally indistinguishable from the funds they manage. This is particularly true of the typical U.S. partnership model where the hedge fund manager is the sole general partner of the fund and the investors are all limited partners. In such a structure, the SEC considers all records of the fund to be records of the general partner, meaning that all of the fund’s activities are subject to SEC examination. So, for example, if the SEC discovered that a hypothetical hedge fund held certain investments in violation of representations made to investors in a private placement memorandum, it could bring an enforcement action against the manager for causing the fund to violate those representations. In that sense, absent Congressional intervention or a judicial reversal, SEC regulation of hedge funds is already here.
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Glassman to Leave the SEC
On Monday, May 15, SEC Commissioner Cynthia Glassman announced that she would not be a candidate for nomination to a second term. SEC commissioners serve staggered, five-year terms, and Commissioner Glassman’s term officially ends on June 5, 2006. It is common, however, for SEC commissioners to remain in office well past that June 5 date, and Commissioner Glassman has indicated that she will remain in office until President Bush nominates, and the Senate confirms, her replacement. Given the shortened legislative calendar this election year, it is possible that Glassman will remain at the SEC until sometime in 2007.
Commissioner Glassman, an economist by training, has been a strong voice for cautious, incremental and economically-rational regulation. Her departure, whenever it actually occurs, will be a loss to those of us who have looked to the SEC to strike an appropriate balance between its dual responsibilities of protecting investors while also promoting capital formation.
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