LegiStorm

Summary:

In an echo of the Robber Baron Era, the late 20th century saw the rise of a new elite class, who made their fortunes not in steel, oil, or railroads, but in financial speculation. These gilded few are the managers of a group of private, unregulated investment partnerships, called hedge funds. Deploying their own capital and that of well-to-do investors, successful hedge fund managers frequently (but not consistently) outperform public mutual funds. Hedge funds use many different investment strategies, but the largest and best-known funds engage in high-risk speculation in markets around the world. Wherever there is financial volatility, the hedge funds will probably be there. Hedge funds can also lose money very quickly. In 1998, one fund—Long-Term Capital Management—saw its capital shrink from about $4 billion to a few hundred million in a matter of weeks. To prevent default, the Federal Reserve engineered a rescue by 13 large commercial and investment banks. Intervention was thought necessary because the fund's failure might have caused widespread disruption in financial markets—the feared scenario then closely resembled what actually occurred in 2008 (except that large, regulated financial institutions took the place of hedge funds). Despite the risks, investors poured money into hedge funds in recent years, until stock market losses in 2008 prompted a wave of redemption requests. In view of the growing impact of hedge funds on a variety of financial markets, the Securities and Exchange Commission (SEC) in October 2004 adopted a regulation that required hedge funds to register as investment advisers, disclose basic information about their operations, and open their books for inspection. The regulation took effect in February 2006, but on June 23, 2006, a court challenge was upheld and the rule was vacated. In December 2006, the SEC proposed raising the "accredited investor" standard—to be permitted to invest in hedge funds, an investor would need $2.5 million in assets, instead of $1 million. In the face of opposition from individuals who did not want to be protected from high-risk, unregulated investment opportunities, the SEC did not adopt a final rule. Hedge funds are not seen as a principal cause of the financial crisis that erupted in 2007. They are, however, widely viewed as part of the "shadow" financial system that includes over-the-counter derivatives, non-bank lending, and other lightly regulated or non-regulated financial sectors. As part of sweeping regulatory reform legislation before the House and Senate in the 111th Congress, certain hedge funds would be required to register with the SEC and to provide information about their positions and trading strategies to be shared with the systemic risk authorities. Under H.R. 4173, passed by the House on December 11, 2009, managers of funds with more than $150 million under management would be required to register as investment advisers with the SEC. They would be required to report (on a confidential basis) certain portfolio information of interest to the Federal Reserve or other systemic risk authorities. The bill provides exemptions for advisers to venture capital funds and small business investment corporations. The Restoring American Financial Stability Act, as ordered reported by the Senate Banking Committee on March 22, 2010, includes similar provisions regarding registration and reporting of systemic risk data. The Senate version exempts venture capital funds and private equity funds. It sets the SEC registration threshold for all investment advisers at $100 million in assets under management. Advisers below that figure would be regulated by the states.