July 26, 2006
Phillip Goldstein has responded to my last post with an argument that the SEC is operating generally outside the scope of the authorizing legislation, the Investment Company Act of 1940. I am generally sympathetic to such claims and believe, like Goldstein, that the SEC has pushed some of its regulations past its Congressional mandates (I have written about this in the regulation of our trading markets under the amendments to the 34 Act). We are dealing here, however, with another act, the Investment Advisers Act of 1940, an act with different goals and policies. The Adviser's Act has both a broader reach and a lighter regulations than the Company Act. A manager can be required to register as an adviser and not advise a mutual fund, for example. At issue is whether, under the Adviser's Act, the SEC rules were unauthorized. Here is where the argument gets strained. Look, I do not like the SEC hedge fund rules either, never have, but the question of SEC authority does not depend on whether the rules represent bad policy.
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You said: "Even though I do not favor the policy judgments behind the new rule I do not believe them to be 'arbitrary'.” I agree on both counts. The rule was not really "arbitrary;" it was in bad faith. "Arbitrary" is a euphemism the court used to soften the blow. This is what the court truly thinks about the SEC's rulemaking:
"There is a disconnect between the factors the Commission cited and the rule it promulgated. That the Commission wanted a hook on which to hang more comprehensive regulation of hedge funds may be understandable. But the Commission may not accomplish its objective by a manipulation of meaning." Does that sound "arbitrary" to you?
BTW, the SEC's arguments for forced registration are all flawed. While some hedge fund managers obviously believe the benefits of registration for them exceed the costs (because they voluntarily registered), others disagree. Why can’t we allow people to choose for themselves? Some have faith in regulation. I have faith in markets and free choice. Just because some regulator likes vanilla ice cream, should I not be allowed to buy chocolate? If the net benefit of regulation is so obvious, surely the market will recognize that and more and more managers will voluntarily register. Long Term Capital? Give me a break! It blew up because it was overleveraged which may have been unwise but did not violate any securities law. Even if the SEC had 10 examiners in LTC’s office 24 hours a day, what would they do? There was no fraud there. Retailization? Nonsense. That is simply an urban myth. I defy you to call any hedge fund manager and ask him if he will take a $25,000 investment or to find any small investor that is invested in a hedge fund. And it is intellectually dishonest to say that a pension fund is indirect “retailization” on behalf of Joe Six-pack. Supposedly, the managers of pension funds are professionals that are qualified to do due diligence on hedge funds before investing. If they aren’t, maybe they should not be even be managing pension funds???? I bet pension funds and mutual funds lost more money in Enron than all the money ever lost in all hedge funds through fraud.
Posted by: Phillip Goldstein | Jul 26, 2006 8:53:55 PM