Hedge Funds Threaten US National Security, Says Grassley

by Leroy Baker, for LawAndTax-News.com, New York

12 March 2007

Sen. Chuck Grassley, ranking member of the Senate Finance Committee, is attempting to add an amendment to the 9/11 commission recommendations bill that would require more hedge fund and money managers to register as investment advisors.

In a floor statement last week, Grassley argued that his amendment would strengthen US homeland security by closing a loophole in securities laws.

Grassley's proposal would amend section 203(b)(3) of the Investment Advisers Act of 1940, and would narrow an exemption from registration for certain investment advisers.

"There is a homeland security element to this fix because it can sometimes be important to know who is managing large sums of money for wealthy foreign investors," Grassley stated.

"For example, it was recently reported that a Boston-based private equity firm, Overland Capital Group, Inc, is under investigation by the IRS and Department of Justice counterterrorism division. Such firms, which manage hundreds of millions of dollars for wealthy investors in total secrecy, ought to have to at least register with the SEC," he added.

Currently, section 203(b)(3) of the Investment Advisers Act provides a statutory exemption from registration for any investment adviser who had fewer than fifteen clients in the preceding 12-month period, and who does not hold himself out to the public as an investment adviser. Grassley explained that his amendment would narrow this exemption, which is currently used by large, private pooled investment vehicles, commonly referred to as hedge funds, to avoid registering with the Securities and Exchange Commission (SEC).

The amendment would authorize the SEC to require investment advisers to register unless the advisor: had $50,000,000 or less in assets under management; had fewer than fifteen clients, did not hold himself out to the public as an investment advisor; and managed the assets of fewer than fifteen investors, regardless of whether the investors participate directly or through a pooled investment vehicle.

"Much has been reported during the last few years regarding hedge funds and the market power they yield because of the large amounts of capital they invest. In fact, some estimates are that these pooled investment vehicles as trading nearly 30% of the daily trades in US financial markets," Grassley continued.

"The power this amount of volume has is not some passing fad, but instead represents a new element in our financial markets. Congress needs to ensure that we know who is running these large vehicles to ensure the security of those markets," he warned.

Grassley highlighted the failure of Amaranth and the increasing interest in hedge funds as investment vehicles for public pension money as a cause for concern, noting "this isn’t just a high stakes game for the super rich. It affects regular investors. Indeed, it affects the markets as a whole."

He continued: "My recent oversight of the SEC has convinced me that the Commission and the Self-Regulatory Organizations (SROs) need much more information about the activities of hedge funds in order to protect the markets from institutional insider trading and other potential abuses. This is one small and simple step toward greater transparency – to require that hedge funds register and tell the regulators who they are. This is not a burden, but rather a simple, common sense requirement for organizations that wield hundreds of billions of dollars in market power every day."

Last year, the D.C. Circuit Court of Appeals overturned a SEC administrative rule that required registration of hedge funds. This decision effectively ended almost all registration of hedge funds with the SEC.

"This amendment is a first step in ensuring that the SEC has the needed statutory authority to do what it attempted to do for the last two years. I urge my colleagues to support this amendment as we work to protect investors large and small," Grassley concluded.

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