SEC To Vote On Hedge Fund Powers Next Week

by Glen Shapiro, LawAndTax-News, Washington

06 July 2007

The Securities and Exchange Commission will vote on 11th July on whether to adopt a new rule allowing it to protect investors in hedge funds, something it is currently unable to do, as a side effect of the Goldstein ruling in 2006 that limited its power to compel funds to register after a see-saw battle in the courts and Congress.

Phillip Goldstein, portfolio manager at hedge fund Opportunity Partners in New York, had accused the SEC of overstepping its authority by changing the definition of a ‘client’ under the Investment Act of 1940, so that virtually all US hedge fund managers would have been required to register as investment advisors. He also argued that the SEC made procedural errors in adopting the rule.regulate the hedge-fund industry in December 2004, when it voted to require hedge-fund advisors to register with the agency, a step that gives regulators the power to conduct routine inspections. After the U.S. Court of Appeals for the District of Columbia Circuit invalidated the rule, SEC Chairman Christopher Cox and his fellow commissioners decided not to appeal the decision.

Instead, Cox explained that the SEC has changed its tack to concentrate on "moving aggressively" on an agenda of rulemaking and staff guidance to address the legal consequences from the invalidation of the rule. "Among the significant new proposals will be a new anti-fraud rule under the Investment Advisers Act that would have the effect of 'looking through' a hedge fund to its investors," Cox stated.

"This would reverse the side-effect of the Goldstein decision that the anti-fraud provisions of the Act apply only to 'clients' as the court interpreted that term, and not to investors in the hedge fund. At my direction, Commission staff are also considering whether we should increase the minimum asset and income requirements for individuals who invest in hedge funds."

Congress has fulminated against the courts for limiting the SEC's powers. In May this year Sen. Chuck Grassley (R - Iowa) introduced legislation that would require hedge funds to register with the Securities and Exchange Commission. “The goal of my initiative is to make our financial markets more transparent,” he said. “Openness is key to trust in those markets.”

“My bill – the Hedge Fund Registration Act – would enable the Securities and Exchange Commission to do what it was already trying to do,” Grassley stated. “The bill gives members of Congress the opportunity to say there should be greater transparency with hedge funds.”

Grassley has been making the case for greater transparency requirements for hedge funds since last year, following passage of the Pension Protection Act of 2006. “I worked very hard for passage of these new pension protections,” he said. “Now I want to make sure that what Congress achieved with my pension legislation isn’t undone by hedge fund secrecy. A lot of pension holders are in the dark about their exposure to hedge fund losses because transparency is so inadequate.”

Grassley surveyed federal agencies about hedge fund transparency last October. Earlier this year, he joined in requesting a review by the Government Accountability Office of the scope of public and private pension plan investments in hedge funds, and what returns and risks are likely for worker retirement funds. In March, Grassley filed similar legislation, introduced as an amendment to homeland security legislation.

Attempts to push through international rules to control or monitor hedge funds, spearheaded by Germany, have so far been unsuccessful. Germany failed to get the G8 to impose a Code of Conduct on hedge funds at the recent summit in Heiligendammin. Deputy Finance Minister Thomas Mirow says that hedge funds should be more transparent. And Bundesbank President Axel Weber says: “It is time to actively develop ambitious best practices maybe in the form of a code of conduct.” But he emphasized that he wasn't expecting any immediate action. “This is a medium- to long-term process,” he said. “What we want to do is to start a discussion process.”

German Finance Minister Peer Steinbrueck has said he wants the outlines of a code of conduct in place by the end of this year, and he may yet get it: Jean-Claude Trichet, president of the European Central Bank, told the Financial Times recently that a voluntary code could cover risk management within hedge funds and the exchange of information between funds and their bankers and between funds and their investors. And at last month's Ecofin meeting in Brussels, European finance ministers, while agreeing not to regulate hedge funds, spoke in favour of a code of conduct to guide their behaviour. New French President Sarkozy has consistently spoken out against hedge funds: "We didn't create the euro to have capitalism without ethics or morals," he said recently, attacking “these aggressive [hedge] funds ... that buy up a company, sell it off in pieces, sack 25% of the staff in the meantime, collect 25% profit and create zero wealth.”

The United States, Japan, Britain, and Canada remain opposed to any interference in the workings of the markets. "Central banks and other regulators should resist the temptation to devise ad hoc rules for each new type of financial instrument or institution," said Fed chairman Ben Bernanke in May.

Germany in particular has been pushing for greater controls over hedge funds ever since the Deutsche Boerse affair in 2005, which saw investors remove Chief Executive Werner Seifert and Chairman Rolf Breuer, leading the SPD's Franz Muentefering to compare the funds to locusts.

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