Dermot Butler speaks out and exposes flaws in the SEC's proposals to increase the US market regulatory burden on US and non-US hedge fund managers.
HW: Are you opposed to US hedge fund regulations?
DB: Regulation of hedge fund managers is perfectly reasonable—and in fact is done almost everywhere else in the world;
My main objection to the SEC proposals is not that I am anti-regulation per se, but I am against decisions being made for what appear to be political motives and backed up by unsustainable arguments.
My other objection is the SEC's assumption that it has the right to impose its regulations on non-US managers, most of whom are already very strongly regulated and have been so for years. Why does the SEC refuse to recognise first class regulators in the UK, Ireland, other EU states etc and exempt managers so regulated?
HW: Can you cite any specific examples to back your objections?
DB: Yes. For example, the SEC claims that by having site inspection rights on hedge fund managers, it will be able to reduce fraud by hedge fund managers; however, the right to visit and review/inspect mutual funds, which the SEC has had for years, did nothing:
a) To prevent a very large number of mutual funds from allowing market timing transactions, which were legal but against many of their own operating rules and therefore against their stated policies; or
b) In identifying "Late Trading" practices, which are illegal;
Both of the above were only discovered after an ex-employee of the Canary fund "squawked" to Elliot Spitzer, who opened the can of worms. It is very likely that if the ex-Canary fellow had said nothing the practices would still be going on to day.
HW: Was the SEC not correct in putting and end to market timing?
DB: The SEC was and is absolutely correct to do so in the context of mutual funds, but in their case for the regulation of hedge funds the SEC tries to imply that because several hedge funds were involved in market timing they were doing something illegal - they were not.
Hedge fund managers have a duty to make profits for their investors by trading markets and taking advantage of market inefficiencies whilst they exist. Market timing was such a market inefficiency which the mutual fund operators could and indeed, should have stopped, if they wanted to.
HW: Are the SEC's concerns not driven by the allegedly rising tide of US hedge fund fraud cases?
DB: The SEC claims that fraud is rife in the hedge fund arena. This is patently not true. The SEC has never proved that there are as many hedge fund frauds per dollar as there are frauds in other investment sectors.
But that is not relevant or important because hedge fund managers are already covered by the anti-fraud rules of the SEC without being otherwise regulated/registered.
HW: The SEC has proposed specific thresholds for regulation, in terms of the numbers of investors and assets under management, what are your comments on these?
DB: I do not see the logic in saying that a hedge fund manager who only manages money for 14 investors should not be regulated, but must have 15 investors before being regulated
In the UK and Ireland (and most other non-US jurisdictions) anyone who gives investment advice to any single person, except perhaps direct close family members or members of a corporate group of companies investing group monies, must be authorised.
I just don't understand why the 14 investors are allowed to be vulnerable, but if a 15th joins them then the SEC will protect them.
HW: What about the proposed threshold for assets under management?
DB: The same applies to the proposed USD 25 million threshold. What makes a small manager less likely to run off with a client's money just because the manager has less than USD 25 million in the kitty? If you review the SEC list of 46 criminal indictments, you will find a high proportion are relatively small sums substantially less than USD 25 million.
HW: Is the SEC not acting in the best interests of investors in proposing registration of all hedge funds targeting US investors?
DB: The SEC claims that because institutions such as large pension plans are now investing in hedge funds and they look after money for a multitude of retail type customers (ie not sophisticated), hedge fund managers should be regulated to protect those investors.
However, the SEC also points out that many large hedge fund managers are already registered because of institutional investor pressure, which is undoubtedly true.
In fact most institutions would not place money with a hedge fund manager unless they were already registered, so the argument is largely self defeating because the managers that the retail pension plan participants need protecting from are in all likelihood already registered and the perceived protection is already provided.
The SEC also seems to ignore the responsibility, experience and qualifications of, and the regulatory oversight that is applied to the managers of such institutions, and who after all, are the persons that place their clients' monies with the hedge funds. Is the SEC's suggestion, by implication, that these managers are incompetent?
The SEC also says that because many hedge fund managers are already registered, the registration is obviously not a burden to the hedge fund manager.
I suggest that those hedge fund managers that are already registered have gone down that route because they wanted institutional money and wouldn't get it otherwise.
Therefore the registration was, should I say "a necessary evil", which they would not otherwise have had to tolerate - a hedge fund manager who doesn't want institutional investors may well find registration an unwelcome burden.
HW: What is the worst scenario for you?
DB: Quite simply, that US investors will lose out as many non-US managers will not be hassled with additional regulations and will not accept money from US investors.
And this could go further—there is the possibility that, if the SEC tries to impose its extraterritorial regulation in non-US jurisdictions, some of those jurisdictions may retaliate by taking a similar stance, requiring US managers to register under their regulations. This could lead to an international regulatory stalemate.
Readers interested in a detailed outline of the SEC's proposals should also read "US Regulatory Exclusive: The SEC's proposals for Hedge Fund Adviser Registration" by Simon Firth of Wilmer Cutler Pickering Hale and Dorr LLP, in which Simon examines the ramifications of the SEC proposals. The article can be found in the European Legal & Regulation section on the homepage at www.hedgeweek.com