Hedge Fund: Management
Regulate Hedge Funds?
What the Industry Needs to Do
Fourth in a Continuing Series
By Russell Jones
Financial Writer
"You cannot bring about prosperity by discouraging thrift. You cannot help small men by tearing down big men. You cannot strengthen the weak by weakening the strong. You cannot lift the wage-earner by pulling down the wage-payer. You cannot help the poor man by destroying the rich. You cannot keep out of trouble by spending more than your income. You cannot further the brotherhood of man by inciting class hatred. You cannot establish security on borrowed money. You cannot build character and courage by taking away men’s initiative and independence. You cannot help men permanently by doing for them what they could and should do for themselves." - Abraham Lincoln
Harvey Pitt, CEO,Kalorama Partners, and former SEC chairmanHarvey Pitt, CEO of global business consulting firm Kalorama Partners, LLC, is former chairman of the Securities and Exchange Commission (SEC). He shares his views on the SEC’s attempt to regulate the hedge fund industry—and what he thinks the industry needs to do now.
“There is a need for best-in-class standards for any industry—and that includes the hedge fund industry,” says Harvey Pitt, CEO, Kalorama Partners, located in Washington, D.C.
“As Teddy Roosevelt put it many years ago, ‘men can never escape being governed … but if they refuse to govern themselves, then in the end they will have to be governed by others.’ My view is that everyone is better off when an industry opts for self-regulation and does so in a responsible manner.”
Pitt starts with the proposition that some form of regulation of the hedge fund industry is inevitable, but thinks the first step should be “through industry attempting to set its own best standards, obviating the need for government to try and regulate the industry. It is exceedingly difficult for the government, which has limited resources and limited capacity, to effect intelligent regulation of a very complex industry. That was the main problem with the SEC’s approach to regulation of hedge funds.”
He adds that he thought the approach was poorly conceived and would have created more problems than it solved.
Asked if he would agree that there are a number of less-burdensome ways than federal regulation to get information to the marketplace, Pitt notes that hedge funds add enormous liquidity to the marketplace, which is in every investor’s interest.
“Hedge funds lead to more efficient and liquid markets and play an important shock-absorbing role that is in the public interest, and therefore people have to take a very measured approach to efforts to regulate them,” he says. “Hedge funds make sense for very sophisticated investors who have both the wherewithal and the capacity to withstand the loss of their entire investment. Because they produce higher returns, they are by definition riskier. The difficulty you have is that retail investors for whom speculative investments are not appropriate have been increasingly able to invest in hedge funds, either directly or indirectly.”
Pitt points out that endowment trusts, pension funds and other similar funds are moving into the hedge fund arena, which he thinks is fine, but his concern is that “the people who are managing those funds understand the risks” and that there is “full and fair disclosure” to their constituents.
“I’m just not sure that goes on all the time.”
The SEC is currently considering raising the net worth standard for a qualified investor in a hedge fund and tightening the anti-fraud provisions that apply to hedge fund advisors.
Pitt believes that these anticipated changes make a great deal of sense. However, as he contemplates the industry’s future, he envisions there will be major pushes, particularly in the new Congress, for some form of federal regulation.
He adds that efforts to create an industry regulatory body deserve encouragement and support.
Are federal regulations the answer?
Pitt doesn’t think so.
“It really is up to the industry itself to come up with best-in-class standards,” he states.
“I am not persuaded that there is a need to do it by government regulation—that may ultimately turn out to be the case, but I’m not persuaded that it is, at least on a starting-out basis.”
He warns that the industry needs to act soon.
“It seems to me that the industry has to recognize the cardinal principle of government—and that is that government, just like nature, abhors a vacuum … so if there is a vacuum, government will rush in to fill it. And that means that the industry needs to go about setting its own standards now.”
