Vive Le Free Markets - Oh Never Mind!

French economist Frédéric Bastiat must be rolling over in his grave as more and more headlines decry capitalism in favor of stringent regulation. In "Policy Makers Weigh Fed Oversight of Derivatives" (February 2, 2009) Wall Street Journal reporter Deborah Solomon writes that Washington movers and shakers are all a twitter about whether to regulate over-the-counter derivative instruments. (One could argue that some regulation currently applies since federally regulated banks dominate this space but that's a discussion for another post.) House Financial Services Chairman Barney Frank (Democrat, Massachusetts) is quoted as saying that "It's not a brand-new regulation but an expansion of the authority of the Federal Reserve."

According to his official website, Senator Chuck Grassley (Republican, Iowa) - along with Senator Carl Levin (Democrat - Michigan) - have introduced legislation to "close a loophole in securities law that allows hedge funds to operate under a cloak of secrecy." In "Grassley and Levin introduce hedge fund transparency bill" (January 29, 2009), this new legislation, if passed, would empower the U.S. Securities and Exchange Commission ("SEC") to force hedge funds to register, thereby putting them under the auspices of the Investment Company Act of 1940. 

In his January 29, 2009 statement, Senator Levin described three basic elements of The Hedge Fund Transparency Act, besides registration. These include the filing of an annual statement that would be available to the public, the maintenance of books and records as required by the SEC and the cooperation with the SEC as relates to examination or information requests.

Levin adds that "The information to be made available to the public must include, at a minimum, the names of the companies and natural individuals who are the beneficial owners of the hedge fund and an explanation of the ownership structure; the names of any financial institutions with which the hedge fund is affiliated; the minimum investment commitment required from an investor; the total number of investors in the fund; the name of the fund's primary accountant and broker; and the current value of the fund's assets and assets under management. This information is similar to what was required in the disclosure form under the SEC's 2004 regulatory effort. The bill also authorizes the SEC to require additional information it deems appropriate."

About two weeks earlier, the President's Working Group on Financial Markets ("PWG") released its best practices for hedge funds, encouraging market participants to adopt comprehensive policies and procedures to (hopefully) thwart problems. The institutional version, entitled "Principles and Best Practices for Hedge Fund Investors: Report of the Investors' Committee to the President's Working Group on Financial Markets" (January 15, 2009), includes an entire section devoted to fiduciary issues. Some of the text is overly broad but it is a good start in terms of getting people to think hard about subjects such as suitability and oversight.

The industry version, entitled "Best Practices for the Hedge Fund Industry: Report of the Asset Managers' Committee to the President's Working Group on Financial Markets" (January 15, 2009), has a noteworthy section about valuation (a topic near and dear to my heart). I am particularly interested in tracking which hedge funds decide to set up a valuation committee, if one does not currently exist. If hedge fund managers follow the report's recommendations, they will likely be spending lots of money on independent pricing services.

Two key questions loom. Will industry attempts at best practices slow down or possibly ward off increased regulation? If not, will regulation and enforcement parallel or conflict with suggested best practices?

This blogger gal goes on the record as favoring industry self-regulation. Sadly, when too few participants fail to recognize the benefits of taking responsibility to preserve open and fair markets, the strong arm of government is inevitable. Consider what Bastiat wrote in the 1800's, still relevant today:

  • "Everyone wants to live at the expense of the state. They forget that the state wants to live at the expense of everyone."
  • "Taxes must, in the end, fall upon the consumer."
  • "The worst thing that can happen to a good cause is, not to be skillfully attacked, but to be ineptly defended."

Whether we end up talking about "smart" or "better" regulation, financial market participants STILL have a chance to eat, live and breathe best practices, for themselves and for their investors.

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