Sunday, March 31, 2013
The Separation of Investments and Management, by John Morley, University of Virginia School of Law, was recently posted on SSRN. Here is the abstract:
This paper suggests a basic shift in the way we think about investment funds. The essence of these funds and their regulation lies not just in the nature of their investments, as is widely supposed, but also and more importantly in the nature of their organization. All types of investment funds — including hedge funds, private equity funds, venture capital funds, mutual funds, exchange-traded funds and closed-end funds — adopt a structure that I term “the separation of investments and management.” Investment enterprises place all of their investment assets into a “fund” with one set of owners, and all of their managers, workers and operational assets into a “management company” or “adviser” with a different set of owners. Investment funds also radically limit investors’ control, sometimes eliminating voting rights and boards of directors entirely. This pattern of organization has never been clearly explained or identified as a common feature of investment funds, but it has often worried and confused commentators and was recently the subject of a case in the U.S. Supreme Court. This paper explains this pattern by showing how it limits fund investors’ control over their managers and exposure to their managers’ profits and liabilities. Investors benefit from these limits for a combination of reasons having to do with exit rights, risk management and the economies of scale that managers can achieve by operating multiple funds. This pattern of organization is a large part of what defines investment funds and animates their regulation.