Sunday, March 11, 2007
Recently posted on SSRN: Dr. Jones and the Raiders of Lost Capital: Hedge Fund Regulation, Part II by JAY VERRET, Delaware Court of Chancery. Here is the abstract:
Hedge funds can sometimes achieve remarkable returns. The market fees exceed that of other asset classes, leading some fund managers to engage in illicit behavior, including fraud, that violates their duty to their investors and tempts institutional investors to violate their fiduciary duty to their principals. I will examine the hedge fund registration requirement struck down during the summer of 2006, as well as the tools used by other regulators to oversee institutional investors. This study relies on a survey of literature on financial regulation, commentary on the hedge fund registration rule, models of self-regulation, and examples in other area of financial regulation that have been successful. The result is a critique of the previous regulatory regime and proposals for the future. The growth of these investments is transforming the price discovery function of the securities markets, resulting in more efficient valuation and robust flows of capital. However, these innovative strategies morph so rapidly, and operationally they are so much leaner, that the simple regulatory strategies of the 33, 34, 40 Acts do not lend themselves to cookie cutter application. Further, the decision-makers are sharply divided. The challenge is crafting a lasting governmental administrative structure with justification that must rest, in part, on faith in a particular regulatory philosophy or market efficiency theory. The present dynamic is entirely novel, but risk is part of the financial regulatory game just as much as it is the essence of finance itself. Therefore, I propose a compromise between the extreme views on hedge fund regulation, using principles from other areas. Self-Regulation is a major theme of this piece. Crafting regulatory safe harbors, permissive information access, and designing legal defenses that encourage the operation of a self-regulatory entity to monitor this industry can help to overcome the severe disadvantage faced by bureaucrats. Further, more elaborate administrative guidance and an element of federal pre-emption, especially in oversight of the entities investing in hedge funds, is advisible.
Recently posted on SSRN: Hedge Funds as Activist Shareholders: Passing Phenomenon Or Grave-Diggers of Public Corporations? by YVAN ALLAIRE IGOPP and MIHAELA E. FIRSIROTU UQAM. Here is the abstract:
The recent wave of corporate scandals has placed corporate executives and boards of directors in the cross hairs of public opinion. However, the tactics of some new wave "investors", particularly some breed of hedge funds (which would be more aptly called "speculative funds"), and their relentless efforts to "commoditize" industrial firms may bring the investor community under closer scrutiny.
By their very actions and successes, hedge funds of the speculative kind are raising a number of very serious issues about the future of corporations and even about their impact on the industrial structures of countries.
This paper stresses several points and arguments made by key researchers:
1. The realities of contemporary stock markets are made of high stock churn rate, short holding period, vote buying activities, record date capture, short selling, stock lending, huge volume of stock derivatives, fairly long period of time between record date and date of annual meeting. As a result, the common assumptions underlying "corporate democracy" have been made obsolete; the huge volume of share trading by hedge funds is a major contributing factor to these developments;
2. Some variants of hedge funds are now in the business of pressuring management and directors to undertake actions they deem likely to boost share prices; to enhance their ability to achieve their ends, they take full advantage of the anomalies and imperfections of corporate democracy;
3. A significant presence in the shareholder base of a company of short-term, transient investors does have an impact on the way a company is managed;
4. In the contemporary world of finance, the "one-share/one-vote" incantation rings hollow; it may be sub-optimal and a source of serious distortions;
5. Unfettered trading in the control of companies, as if they were a commodity, a metal, or a piece of commercial real estate, may be the goal of some players in the financial markets; but the aggressive pursuit of that goal may bring about government policies and popular attitudes far less beneficial to reasonable investors.
This paper reviews the range of options proposed to curtail their ability to do harm. As documented by Black and Hu (2006a,b) and Martin and Partnoy (2005), their ability and willingness to capitalize on the weaknesses of corporate democratic processes raise serious issues, which have led to calls for measures to fence in these funds and limit the damages they may inflict on societies.