May 27, 2003

Chairman Donaldson Briefs Baker's Panel on SEC's R

WASHINGTON (HedgeWorld.com)--The chairman of the Securities and Exchange Commission told a subcommittee of the House of Representatives that he believed the SEC's round table on hedge funds last week was a resounding investigatory success.

It was an "excellent example of how the SEC can operate as an effective regulator, by assembling a highly knowledgeable group of experts representing a variety of viewpoints to debate important issues," according to William H. Donaldson's prepared testimony, Thursday morning, to the capital markets subcommittee of the Financial Services Committee.

The subcommittee chair, Rep. Richard Baker (R-La.) said that the committee eagerly awaits the SEC report, which now is expected early this fall.

The SEC chairman stressed that the investigation continues, that the round table was only a part of it and that no conclusions have been reached. He said the reason an investigation is appropriate is due to the rapid growth in the hedge fund industry in recent years. Panelists at the round table estimated that over the last few years, there have been approximately US$25 billion a year in new assets invested in hedge funds.

If Mr. Donaldson's remarks are a good sign of the way the wind is blowing within the SEC, it seems unlikely that the ongoing investigation will lead to new restrictions on short selling. Mr. Donaldson was reassuring on the subject, observing that the short selling, at least with regard to exchange traded stocks, is already subject to greater regulation than other trading strategies, and that "if short sellers make false statements about issuers for the purpose of lowering their stock prices, that conduct is actionable under the anti-fraud and anti-manipulation provisions of the federal securities laws."

He did express concern, though, about the fee structure of hedge funds. It aligns the interests of managers and investors, he said, on the upside but not on the downside. Furthermore, a single investment adviser sometimes manages both a hedge fund and a mutual fund, where the former offers the manager an opportunity to earn a performance fee that the latter does not. "Round table panelists generally agreed," the chairman said, "that this situation does raise a conflict of interest that requires appropriate disclosure, allocation and other procedures on the part of the adviser."

Other Witnesses

The committee heard from several other witnesses Wednesday, including: John Mauldin, president Millennium Wave Investments LLC, Fort Worth, Texas; David A. Rocker, president of Rocker Partners LP, New York; Terry F. Lenzner, founder of Investigative Group International Inc., Washington; Owen Lamont, associate professor of finance, Graduate School of Business, University of Chicago; Paul Kamenar, senior executive counsel, Washington Legal Foundation.

Mr. Mauldin suggested that regulators ought to make hedge fund strategies available to the middle class, perhaps by simply allowing mutual funds to use strategies now exclusive to hedge funds or, in the alternative, by creating a hybrid investment vehicle, which he labeled a Hedge Fund Investment Company. "The current two class structure limits the investment choices of average Americans and makes the pursuit of affordable retirement more difficult than it should be," Mr. Mauldin said. He also expressed doubts about a regulatory system based on a distinction between sophisticated and unsophisticated investors. After all, he told the subcommittee, "it is no more difficult to understand the large majority of hedge fund strategies than it is to understand the business plan and risks of an investment in Cisco or other related technology company."

In another development of keen interest to the alternative investment community, the full Financial Services Committee, chaired by Michael G. Oxley (R-Ohio), voted Wednesday to approve H.R. 2120, the Financial Contracts Bankruptcy Reform Act of 2003, which would make it easier for financial institutions to detangle their obligations in the event a counterparty goes bankrupt. The legislation is intended to prevent the failure of one financial institution from leading to the collapses of other institutions.

The same provisions recently passed the House as part of a broader bankruptcy reform package, H.R. 975, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2003. But since bankruptcy reform is a broad issue subject to legislative deadlock, as recent sessions of Congress have abundantly illustrated, Rep. Patrick J. Toomey (R-Penn.) introduced H.R. 2120 as a standalone.

CFaille@HedgeWorld.com

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