Quarles Speaks To Senate Banking Committee On Hedge Fund Regulation

by Glen Shapiro, LawAndTax-News.com, New York

27 July 2006

Speaking on Tuesday, Randal Quarles, Under Secretary for Domestic Finance with the US Treasury discussed the regulation of hedge funds, a hot topic since the DC Court of Appeals overturned the Securities and Exchange Commission's amended hedge fund registration rule, and several Democrat lawmakers announced that they were seeking to reverse the decision.

Speaking before the Senate Committee on Banking, Housing and Urban Affairs, Quarles announced that:

"In May, before a subcommittee of this panel, I presented testimony regarding the role that hedge funds play; that is, what hedge funds do for and in our financial markets. As I said then, if government addresses the question of regulation of any financial institution or activity without a clear understanding of the place it plays in our financial system, we run the risk of imposing unnecessary, excessive, or inappropriate legislation."

"As we consider the regulation of hedge funds, we should keep in mind that the role they fulfill in our financial markets is continuously evolving; and in recent years it has been evolving rapidly."

Speaking with regard to the SEC's amended hedge fund registration rule, he stated:

"In late 2004, the Securities and Exchange Commission (SEC) issued a final rule that required hedge fund advisers to register with the Commission, mainly out of a perceived need to address increasing instances of hedge fund fraud and a concern that less sophisticated investors were becoming increasingly exposed to hedge fund investments, either directly or indirectly through their pension plans. The rule went into effect on February 1, 2006, prompting more than 1,100 previously unregistered hedge fund advisers to register with the SEC."

"Neither Treasury nor the PWG (President's Working Group on Financial Markets) ever took a formal position on the rule. We did work with the SEC, however, both bilaterally and through the PWG, to make sure we understood the SEC's rationale for their rule, and what their goals and expectations were regarding its implementation. Although we did not formally comment on the SEC's proposed rule, we did ask the SEC to work with the Commodity Futures Trading Commission (CFTC) to avoid potential duplicative registration requirements for CFTC-registered commodity pool operators and commodity trading advisers."

"This past June, the U.S. Court of Appeals for the D.C. Circuit ruled that the SEC's hedge fund adviser registration rule was arbitrary in the way it redefined the term "client" so as to bring hedge fund advisers under the registration requirements of the Investment Advisers Act, and the court therefore vacated the rule. SEC Chairman Cox, in his statement on the Court's decision, expressed a very pragmatic approach to dealing with this decision. He noted that the SEC will continue to work with the PWG as it reevaluates its approach to hedge fund activity and as the SEC considers alternative courses of action. We look forward to working with Chairman Cox and the SEC staff on these issues."

He concluded:

"Thank you again for allowing the Treasury Department to participate this afternoon. As I have mentioned, the question of the regulation of hedge funds must be carefully considered in light of the important role they play in our financial markets."

"It is for that reason that Treasury is examining in detail the issues I have discussed this morning, with a view to evaluating whether the growth of hedge funds – as well as other phenomena such as derivatives and additional alternative investments and investment pools – hold the potential to change the overall level or nature of risk in our markets and financial institutions. This examination will involve bringing key government officials together to review their approaches to these financial market issues."

"The first such meeting was held last week, chaired by Assistant Secretary of the Treasury Emil Henry, and will be followed by further discussions in the future. We are also beginning a broad outreach to the financial community to help us examine these questions. As part of this comprehensive review chaired by the Treasury, we will be working with the SEC – both bilaterally and through the PWG – as Chairman Cox and the Commission consider alternative courses of action following the D.C. Circuit Court's recent decision."

"Looking forward, we will be focused on seeking to understand in the most comprehensive way possible whether and how changes in the structure of the financial services industry – of which the rapid growth of new forms of capital accumulation, such as hedge funds, is just one example – have materially affected the efficiency with which markets intermediate risk, whether risk is pooled in different ways or in different places than it has been in the past – and if so, what appropriate policy responses might be."

"We will seek to be forward looking and to think about these changes not in a fragmented fashion, but in a comprehensive way. At the moment it is too soon to say what initiatives will result from this focus, but this is the lens through which we will filter the various ideas and efforts with which we will all be grappling over the next few years."

A comprehensive report in our Intelligence Report series examining offshore investment, offshore stock exchanges, and hedge funds is available in the Lowtax Library at http://www.lowtaxlibrary.com/asp/subs_reports.asp and a description of the report can be seen at http://www.lowtaxlibrary.com/asp/description_report9.asp

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