Tag: Hedge Funds

Do Hedge Funds Create Criminals?

Lynn Stout takes the recent charges against arrest of Raj Rajaratnam, founder of the Galleon Group, and the recent raids on expert networks as an indictment of the entire hedge fund industry. She makes the mistake of using a few bad apples to state the whole industry is corrupt. The vast majority of hedge funds operate completely in compliance with the law and ethical obligations. You would not say the entire energy industry is corrupt because of the failures of Enron.

The expert networks Stout mentions are not your classic cases of insider trading. The involved parties were trying to get information about how a company is doing. By getting access to orders for computer chips you can make some estimates about how many computers a company is producing. Depending on the type of information, some should have been protected and some is just business intelligence.

After all, there is nothing wrong with looking at satellite photos of a shopping center to see how many cars are in the parking lot. Compare the photos from year to year and you may have a good indication of whether sales are up or down.

There is plenty of evidence demonstrating that bad environments contribute to bad behavior. That is backbone for compliance. Create an environment where there is more pressure to follow the rules than to break the rules.

Stout lays out three social signals that have been repeatedly shown in formal experiments to suppress pro-social behavior:

Signal 1: Authority Doesn’t Care About Ethics.
Signal 2: Other Traders Aren’t Acting Ethically.
Signal 3: Unethical Behavior Isn’t Harmful.

Signal 1 is the classic call for a tone from the top. Signal 2 is the classic call for corporate culture. Signal 3 is the classic call for regulatory (and criminal) enforcement.

No. Hedge funds do not create criminals. Unethical work environments create criminals. It’s a problem not just at hedge funds, but every industry.

Lynn Stout is the Paul Hastings Professor of Corporate and Securities Law at the UCLA School of Law and the author of Cultivating Conscience: How Good Laws Make Good People.

Sources:

SEC to Consider New Rules for Fund Managers

On Friday, The Securities and Exchange Commission will be considering rules that should be of interest to private investment fund managers.

It looks like we may have the first look at how the SEC will define a venture capital fund and who will fit into that new exemption to registration under the Investment Advisers Act. Section 407 of Dodd-Frank puts the onus on the SEC to define ‘venture capital fund.’

My guess is that the definition will be very narrow and many venture capital fund managers will not be happy with the definition.

Open Meeting – Friday, November 19, 2010 – 10:00 a.m.

The subject matter of the Open Meeting will be:

  • The Commission will consider whether to propose new rules and rule amendments under the Investment Advisers Act of 1940 to implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act. These rules and rule amendments are designed to give effect to provisions of Title IV of the Dodd-Frank Act that, among other things, increase the statutory threshold for registration by investment advisers with the Commission, require advisers to hedge funds and other private funds to register with the Commission, and address reporting by certain investment advisers that are exempt from registration.
  • The Commission will consider whether to propose rules that would implement new exemptions from the registration requirements of the Investment Advisers Act of 1940 for advisers to venture capital funds and advisers with less than $150 million in private fund assets under management in the United States. These exemptions were enacted as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The proposed rules also would clarify the meaning of certain terms included in a new exemption for foreign private advisers.
  • The Commission will consider whether to propose new rules under Section 763(i) of the Dodd-Frank Wall Street Reform and Consumer Protection Act governing the security-based swap data repository registration process, the duties of such repositories, and the core principles applicable to such repositories.
  • The Commission will consider whether to propose Regulation SBSR under Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act to provide for the reporting of security-based swap information to registered security-based swap data repositories or the Commission and the public dissemination of security-based swap transaction, volume, and pricing information.

At times, changes in Commission priorities require alterations in the scheduling of meeting items. For further information and to ascertain what, if any, matters have been added, deleted or postponed, please contact: The Office of the Secretary at (202) 551-5400.

Perspectives on Hedge Fund Registration

paul-kanjorski

On Thursday, May 7, 2009,  the House Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises held a hearing on: “Perspectives on Hedge Fund Registration”.

During the hearings on legislation to regulate hedge fund advisers, Rep. Paul Kanjorski said that hedge funds deserve to “continue swimming in the deep end of the pool.” But if hedge funds want to “continue to swim” in the US capital markets, they must, “fill out the forms and get an annual pool pass.”

Rep.  Kanjorski also stated that “Congressmen Capuano and Castle have drafted a good bill to accomplish the goal of registering hedge fund investment advisers.” That sounds like an endorsement of the Hedge Fund Adviser Registration Act.

Webcast:

Opening  Statement:

Witness List & Prepared Testimony:

  • Mr. Todd Groome, Chairman, Alternative Investment Management Association
  • The Honorable Richard H. Baker, President, Managed Funds Association
  • Mr. James S. Chanos, Chairman, Coalition of Private Investment Companies
  • Ms. Orice Williams, Director, Financial Markets and Community Investment Team, Government Accountability Office
  • Mr. Britt Harris, Chief Investment Officer, Teacher Retirement System of Texas

Recommended Annual Review for Hedge Funds and Other Private Fund Managers

bingham_logoBingham McCutchen has put together a Recommended Annual Review for Hedge Funds and Other Private Fund Managers.

Bingham put together a laundry list of regulations, policies and filings that you should review on at least an annual basis:

  • Compliance Policies and Procedures
  • Form ADV Part 1 and Form ADV Part II
  • Form SH
  • Anti-Fraud Rule Adopted by the SEC for Naked Short Sales
  • Blue Sky Filings and Amendments to Form D
  • Form 13F
  • Schedule 13D/13G
  • Forms 3, 4 and 5
  • Audited Financial Statements
  • Offering Document Updates
  • Ongoing ERISA Compliance
  • Section 457A
  • Section 409A
  • CFTC Requirements
  • Liability Insurance
  • Employee Training
  • Privacy Policy

Disclosure: The Wife is an attorney at Bingham.

What is a Hedge Fund?

The President’s Working Group on Financial Markets Report of the Asset Managers’ Committee uses this as a definition of “hedge fund.”

By “hedge fund” we mean a pooled investment vehicle that generally meets most, if not all, of the following criteria:  (i) it is not marketed to the general public (i.e., it is privately offered), (ii) its investors are limited to high net worth individuals and institutions, (iii) it is not registered as an investment company under relevant laws (e.g., U.S. Investment Company Act of 1940), (iv) its assets are managed by a professional investment management firm that is compensated in part based upon investment performance of the vehicle, (v) its primary investment objective is investing in a liquid portfolio of securities and other investment assets, and (vi) it has periodic but restricted or limited investor redemption rights. (This description is based in part on the definition in the Managed Funds Association’s 2007 Sound Practices for Hedge Fund Managers.) Although hedge funds may invest in private equity and real estate, this Report is not addressed to the specific considerations of private equity or real estate funds.  We use the terms “alternative asset manager” and “manager” to refer to the entity that establishes the investment profile and strategies for the hedge fund and makes the investment decisions on its behalf.

Hedge Fund Registration Act

Senator Charles Grassley of Iowa is looking to expand the registration requirements of the Investment Advisers Act. According to Jim Hamilton’s World of Securities Regulation, the Senator Will Reintroduce in 111th Congress Bill Requiring SEC Registration of Hedge Fund Advisers. The Washington Post story has Senator’s Grassley’s statement coming out of the House Oversight and Government Reform Committee hearing: Fund Chiefs Back Oversight.

The SEC issued a rule in 2004 to try to expand the registration requirement under the Investment Advisers Act by defining client to mean each of the limited partners in a private investment fund, not just the fund itself. That rule was overturned by Goldstein v. SEC which found the rule to be broader than what was authorized under the Investment Advisers Act.

See also:

Ruder Calls for Regulation of Hedge Funds

Former SEC Chair David Ruder testified to the House Oversight and Government Reform Committee that the SEC should be given the power to register hedge funds advisers and force them to disclose their risks. This testimony was part of the testimony of Congress Examining Hedge Funds. You can read the Testimony of David Ruder (.pdf).

Mr. Ruder states that:

New regulations are needed in order to protect hedge fund investors and in order to monitor hedge fund contributions to systemic risk. These regulatory needs can be accomplished by giving the Securities and Exchange Commission power to register and inspect hedge fund advisers, including the power to require disclosure of activities that might injure investors, power to require hedge fund advisers to disclose hedge fund risk activities, and power to monitor and assess the effectiveness of hedge fund risk management systems.

I disagree with the statement that regulation is needed to protect investors in hedge funds.  The exemptions from registration of hedge funds is for those funds and advisers with significant assets and understanding of risks.

As for the systemic risk posed by hedge funds, I remain unconvinced. Mr. Ruder refers back to the Long Term Capital Management in the late 90s.  We have not been hearing about hedge funds causing the current crisis. It appears that the investment banks and rating agencies were the parties most at fault. It also seems the lack of regulation in the derivatives markets, especially Credit Default Swaps, and poorly underwritten residential mortgages and mortgage securities were the tools that caused the most damage.

Congress Examining Hedge Funds

On Thursday November 13, 2008, The House Commitee on Oversight and Government Reform held a hearing on hedge funds and the financial market.

The following witnesses testified:

  • Professor David Ruder, Northwestern University School of Law, Former Chairman, U.S. Securities and Exchange Commission
  • Professor Andrew Lo, Director, MIT Laboratory for Financial Engineering, Massachusetts Institute of Technology, Sloan School of Management
  • Professor Joseph Bankman, Stanford University Law School
  • Houman Shadab, Senior Research Fellow, Mercatus Center, George Mason University
  • John Alfred Paulson, President, Paulson & Co., Inc.
  • George Soros, Chairman, Soros Fund Management, LLC
  • James Simons, President, Renaissance Technologies, LLC
  • Philip A. Falcone, Senior Managing Partner, Harbinger Capital Partners
  • Kenneth C. Griffin, Chief Executive Officer and President, Citadel Investment Group, LLC