SEC’s latest proposal makes no sense

The Securities and Exchange Commission continues to forge ahead in its quest to wrap some kind of regulatory lasso around the $1.2 trillion hedge fund industry.
Why it is doing so isn’t entirely clear.
The SEC’s latest proposal, introduced in December and open for public comment through March, would significantly narrow the
pool of potential investors by
setting a minimum-liquid-net-worth requirement at $2.5 million, not including the value of an investor’s home.
The current minimum standard, which was set in 1982, requires an investor to have a total net worth, including the value of a home and a range of other assets, of $1 million.
The liquid-asset requirement, which automatically excludes most real estate from the calculation, is no small distinction.
A shrinking clientele
Under the current rules, about 8.5% of U.S. households qualify to invest in a hedge fund, according to InvestorsInsight Publishing Inc.’s website. Under the proposed revisions, the percentage of eligible households would drop to 1.3%, the Dallas-based research firm calculates.
This has the potential to become a very big challenge for an industry that has swelled to more than 10,000 hedge funds and counting.
Some hedge fund managers have pushed for more-relaxed investor requirements, arguing — perhaps philosophically, perhaps practically, perhaps desperately — that restricting access to rich people only discriminates against those people who are not rich.
The new regulatory proposal is likely to be part of the buzz this week in Key Biscayne, Fla., where the industry’s Washington-based trade group, the Managed Funds Association, is holding its annual networking conference.
The first session on the agenda this morning is dedicated to regulatory issues.
Last year at this time, the hedge fund industry was reluctantly settling into the idea that most hedge fund managers were being required to register with the SEC as investment advisers.
It took a U.S. Court of Appeals panel and the determination of a single hedge fund manager, Phillip Goldstein of Saddle Brook, N.J.-based Bulldog Investors General Partnership, to get that rule overturned in June.
As with the current proposal, the failed registration rule from the start raised more questions than answers.
For instance, despite its dogged efforts toward increased jurisdiction over the hedge fund industry, the SEC never quite addressed the idea of exactly how or if it planned to monitor effectively the diverse and dynamic world of hedge funds.
By some measures, it could be argued that until recently, the hedge fund industry has enjoyed a kind of free pass from most regulatory scrutiny.
Part of the justification for that gets back to the investor requirements, or suitability standards, with regard to wealth.
Since it would be cynical and mean to assume that rich people deserve less regulatory protections, because they can afford to lose some of their money, we are left with the popular theory that greater wealth equals greater sophistication and financial savvy.
The SEC’s most recent proposal does little to dispute that theory beyond suggesting that perhaps $1 million worth of sophistication just ain’t what it used to be.
And just in case a $2.5 million pool of liquid assets also fails to make someone a lot smarter, the SEC’s current proposal also would prohibit hedge fund managers from “making false or misleading statements, or otherwise defrauding investors or prospective investors.”
Beyond the simple silliness of a proposal stating essentially that it is wrong to commit fraud, the SEC has overlooked the fact that, registered or not, hedge fund managers already are subject to the anti-fraud rules laid out in the Investment Advisers Act of 1940.
Suddenly, we’re reminded of the regulatory zeal leading up to the Sarbanes-Oxley Act of 2002, as well as the present-day reality of dealing with multiple layers of laws and expenses all designed around the crimes that some companies had already committed.
With that in mind, it seems that any rule which makes fraud illegal twice is probably headed in the wrong direction.