July 19, 2006
Phillip Goldstein wrote a reply to my earlier note on his case against the SEC that successfully threw out the hedge fund registration rules. His makes a good point. Too good. His argument stands on formality -- a hedge fund manager has one client, the fund itself. The fund investors are not his clients. An argument on formality has extensions into the form of the fund -- a general partnership is different from an LLC or a corporation. In a general partnership, the partners traditionally would each be clients. The SEC was willing, by rule, to treat all the business forms the same, however. The point is that a definition of client should not stand on formality and that the SEC is in a good position to craft a definition. The definition can be functional or can be a bright line test to substitute for a case by case functional analysis. Note that the industry hates the functional tests and loves the bright line tests because it enhance the predictability of their business arrangements. The SEC choose the bright line test and the court rejected it. I did not like the SEC rules but I would not reject the rules based on formality -- this will come around to bite the industry that pushed the argument.
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OK, let's talk about the big picture. In 1940 Congress explicity excluded hedge funds from registration under the Investment Company Act. In testimony before a Senate committee, David Schenker, the SEC’s representative explained: “We do not want any part of [private funds]; and so . . . even though you engage in the same type of activity as an investment company, if you have less than 100 security holders you are not a public investment company and not within the purview of this legislation.” As to the size of private funds, Schenker said: “The total assets play no part [and] the size is not the definitive or determinative factor.”
If things have changed since then that merit additional regulation of hedge funds (a debatable premise as evidenced by the controversy over this issue), don't you think Congress should be the body to make that determination? Or should we just junk the Constitution and set up self-perpetuating agencies where unaccounatble buraucrats can make policies and de facto laws? I guess so until they make a "rule" that adversely affects enough people that they rethink the wisdom of the regulatory state.
Posted by: Phillip Goldstein | Jul 25, 2006 7:43:08 PM