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The Effect of the Dodd-Frank Act on Hedge Fund Performance – Presentation at George Washington University Law School

THE CENTER FOR LAW, ECONOMICS AND FINANCE
AT
THE GEORGE WASHINGTON UNIVERSITY LAW SCHOOL
FOURTH ANNUAL JUNIOR FACULTY BUSINESS AND FINANCIAL LAW WORKSHOP AND JUNIOR FACULTY SCHOLARSHIP PRIZES

Sponsored by Schulte Roth & Zabel LLP

The George Washington University Law School 2000 H Street, NW
Washington, DC 20052
February 7-8, 2014

Friday February 7

Welcome, FACULTY CONFERENCE CENTER, B 505

Gregory Maggs, Interim Dean, GW Law School
Arthur Wilmarth, Professor of Law, GW Law School; Executive Director, C-LEAF Lisa Fairfax, Leroy Sorenson Merrifield Research Professor of Law, GW Law School

Session 1: Systemic Risk Paradox

Felix Chang, University of Cincinnati College of Law

Commentators:

Heidi Schooner, Columbus School of Law, Catholic University of America

John Buchman, Executive Counsel- Regulatory Affairs, General Electric Capital Corporation

Session 2: Bankruptcy Stigma: A Socio-Legal Study

Michael Sousa, University of Denver College of Law

Commentators:

Robert Lawless, Associate Dean for Research, Co-Director, Illinois Program on Law, Behavior and Social Science, University of Illinois College of Law

Deborah Thorne, Wagner Teaching Professor, Department of Sociology and Anthropology, Ohio University

Session 3: The SEC and the Courts’ Cooperative Policing of Related Party Transactions

Geeyoung Min, University of Virginia School of Law

Commentators: Joan Heminway, W.P. Toms Distinguished Professor of Law, University of Tennessee College of Law

David Lynn, Partner, Morrison & Foerster LLP

Session 4: The (Un)enforcement of Corporate Officer Duties

Megan Shaner, University of Oklahoma College of Law

Commentators:

Lawrence A. Hamermesh, Ruby R. Vale Professor of Corporate and Business Law, Director, Widener Institute of Delaware Corporate and Business Law, Widener University School of Law

Lyman Johnson, Robert O. Bentley Professor of Law, Washington and Lee University School of Law

Session 5: Testing the Bounds of Fiduciary Obligations: An Empirical Study of U.S. Mutual Fund Proxy Voting Behavior

Olivia Dixon, The University of Sydney

Commentators:

JIll Fisch, Perry Golkin Professor of Law, Co-Director, Institute for Law and Economics, University of Pennsylvania Law School

Lisa Fairfax, GW Law School

Session 6: Functional Financial Regulation

Sung Eun (Summer) Kim, University of Illinois College of Law

Commentators:

Richard Carnell, Associate Professor of Law, Fordham University School of Law

Art Wilmarth, GW Law School

Session 7: The Outside Investor: Citizen Shareholders and Corporate Law Alienation

Anne Tucker, Georgia State University College of Law

Commentators:

Jeff Mahoney, General Counsel, Council of Institutional Investors

Jennifer Taub, Associate Professor of Law, Vermont Law School

Saturday February 8

Session 8: Hedge Fund Performance After the Dodd-Frank Act-A Regression Discontinuity Analysis

Wulf Kaal, University of St. Thomas School of Law

Commentators:

William Bratton, Deputy Dean and Nicholas F, Gallicchio Professor of Law and Co-Director, Institute of Law and Economics, University of Pennsylvania Law School

Sabastian V. Niles, Counsel, Wachtell, Lipton, Rosen & Katz, LLP

Session 9: Professional Responsibility of Investment Bankers

Andrew Tuch, Washington University School of Law

Commentators:

William Wilhelm, Jr., William G. Shenkir Eminent Scholar Finance, University of Virginia, McIntire School of Commerce

Andre Owens, Partner, WilmerHale LLP Morning Break

Session 10: Insider Trading in Derivative Markets (And What it Means for Everyone Else)

Commentators: James Cox, Brainerd Currie Professor of Law, Duke University School of Law School

Arthur Wilmarth, GW Law School

Session 11: Do the Securities Laws Matter? The Matter of Convergence of the Loan and Bond Markets

Elisabeth de Fontenay, Duke University School of Law

Commentators:

Donald Langevoort, Thomas Aquinas Reynolds Professor of Law, Georgetown University Law Center

Theresa Gabaldon, GW Law School

Session 12: The Special Problem of Banks and Crime

Gregory Gilchrist, University of Toledo College of Law

Commentators:

Samuel Buell, Professor of Law, Duke University School of Law

Cornelius Hurley, Director, Center for Finance, Law & Policy, Professor of the Practice of Banking Law, Boston University School of Law

 

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New Hedge Fund Data on SEC Form PF – Presentation at Investment Fund Roundtable

Investment Fund Roundtable program 1 2014

Investment Funds

A Roundtable Discussion

Brooklyn Law School

Friday, January 31, 2014

Discussion Agenda

Session I:      Fiduciaries: Harmonizing the Standard of Conduct for Financial Intermediaries

Moderator: Deborah A. DeMott, Duke University School of Law

  • Is there and ought there be a common standard of conduct for financial intermediaries toward retail investors?
  • What are the SEC, the Department of Labor (regarding ERISA fiduciaries), and the Municipal Securities Rulemaking Board doing on this question?
  • What are the implications of these standards on revenue sharing and other costs?

Session II:    Enforcement: SEC Enforcements and Settlements for Funds, Trustees & Advisers

Moderator: Jill E. Fisch, University of Pennsylvania Law School

  • What has been the effect of Judge Jed Rakoff’s rejection of the SEC settlement with Citigroup?
  • What sorts of conditions on settlement might fund advisers and trustees expect to see in future?
  • On what topics will the SEC focus its enforcement efforts in future?

Session III:   Compliance: SAC & The Rising Role of Compliance in Private Funds

Moderator: Eric D. Roiter, Boston University School of Law

  • What enhancements are funds, especially private funds, making in their compliance efforts with, e.g., Title IV of Dodd-Frank, FSOC, Form PF, and Rule 506(c) under the JOBS Act?
  • What will be the effect of compliance as a defense to supervisory liability in cases such as SAC?
  • What effect, if any, would the creation of a self-regulatory organization for investment advisers have?

Session IV:   Market Developments: Challenges from Changes in Market Structure & Technology

Moderator: James D. Cox, Duke University School of Law

  • How effective and suitable are Target-Date Funds for retirees?
  • What are the challenges facing fund advisers and directors from algorithmic and high-frequency trading?
  • How problematic are the technological issues that generate trading errors, such as those affecting Knight Capital, Goldman, et al.?

Roundtable Participants

Hilary J. Allen

Assistant Professor of Law

Loyola University New Orleans

College of Law

(visiting Brooklyn Law School)

Diane E. Ambler

Partner

K&L Gates

Lee Augsburger

Chief Ethics & Compliance Officer

Prudential Financial, Inc.

William A. Birdthistle

Associate Professor of Law

& Freehling Scholar

Chicago-Kent College of Law

Mercer E. Bullard

Associate Professor of Law

University of Mississippi School of Law

(former Assistant Chief Counsel, SEC Division of Investment Management)

James D. Cox

Brainerd Currie Professor of Law

Duke University School of Law

Quinn Curtis

Associate Professor of Law

University of Virginia School of Law

Deborah A. DeMott

David F. Cavers Professor of Law

Duke University School of Law

Lisa M. Fairfax

Leroy Sorenson Merrifield Research

Professor of Law

George Washington University Law School

Jill E. Fisch

Perry Golkin Professor of Law

University of Pennsylvania Law School

James Fanto

Professor of Law & Co-Director for the

  Study of Business Law & Regulation

Brooklyn Law School

Tamar Frankel

Michaels Faculty Research Scholar 

  Professor of Law

Boston University School of Law

Erik Gerding

Associate Professor of Law

University of Colorado Law School

Jeffrey N. Gordon

Richard Paul Richman Professor of Law

Columbia Law School

M. Todd Henderson

Professor of Law

  & Aaron Director Teaching Scholar

University of Chicago Law School

Kathryn Judge

Associate Professor of Law

Columbia Law School

Wulf A. Kaal

Associate Professor

University of St. Thomas School of aw

J.B. Kittredge

General Counsel

Grantham, Mayo & Van Otterloo LLC

H. Norman Knickle

Attorney-Adviser

Boston Regional Office

U.S. Securities and Exchange Commission

Anita K. Krug

Assistant Professor of Law

University of Washington School of Law

Arthur B. Laby

Associate Professor

Rutgers School of Law – Camden

(former SEC Assistant General Counsel)

Simon M. Lorne

Vice Chairman & Chief Legal Officer

Millennium Partners L.P.

Martin E. Lybecker

Partner

Perkins Coie LLP

(former Associate Director, SEC Division of

Investment Management)

Patricia A. McCoy

Connecticut Mutual Professor of Law

University of Connecticut School of Law

John D. Morley

Associate Professor of Law

Yale Law School

Alan Palmiter

Howard L. Oleck Professor of Business Law

Wake Forest University School of Law

Robert A. Robertson

Partner

Dechert LLP

Eric D. Roiter

Lecturer in Law

Boston University School of Law

(former SEC Assistant General Counsel)

Peter M. Rosenblum

Partner

Foley Hoag LLP

Natalya Shnitser

Associate Research Scholar in Law

Yale Law School

Erik R. Sirri

Professor of Finance

Babson College

(former SEC Director, Trading

& Markets)

Jennifer S. Taub

Associate Professor of Law

Vermont Law School

W. Danforth Townley

Attorney Fellow, SEC Div. of Investment Management

Dirk Zetzsche

Propter Homines Chair for Banking

  & Securities Law

Universität Liechtenstein

 

Hedge Funds – A New Era of Transparency

Hedge funds play a critical role in capital formation, and are increasingly influential participants in the capital markets.  The hedge fund industry is transitioning from a secretive industry to a widely-recognized and influential group of investment managers.

Mary Jo White’s speech at the Managed Funds Association Conference on October 18, 2013 underscores the transformation of the hedge fund industry and highlights the important changes in the regulatory landscape pertaining to the hedge fund industry. I had previously commented on this here.

The changes introduced by the Dodd-Frank Act and the JOBS Act may be described as tectonic shifts for the hedge fund industry.  The Dodd-Frank Act required most advisers to hedge funds and other private funds to register with the SEC and directed the SEC to collect information, on a confidential basis, from private fund advisers regarding the risk-profiles of their funds. See further on the Effects of the Dodd-Frank Act on the Hedge Fund Industry here.

Similarly, the JOBS Act, directed the SEC to lift the decades-old ban on general solicitation that applied when companies or funds make private securities offerings under Rule 506 of Regulation D.  As a result, as of September 23, 2013, hedge fund managers are free to communicate with investors and the public. They can advertise, talk to reporters, and speak at conferences.  See further on Lifting the Ban on General Solicitation  here.

Mary Jo emphasizes in her speech: “Our knowledge of the markets and understanding of your businesses is also enhanced when [private fund managers] provide us with non-public data on [private] funds’ risk profiles, which is required by new Form PF mandated by the Dodd-Frank Act. Form PF provides information on the types of assets [private fund managers] are holding to help to inform government regulators tasked with monitoring systemic risk. Using this information, regulators can then assess trends over time and identify risks as they are emerging, rather than reacting to them after they unfold [. . . ] This era of hedge fund transparency is also new for [the SEC]. We need to continuously ensure that we – as regulators – are asking for the right information, in the most appropriate way.”

The effects of the new era of hedge fund transparency are still largely unclear and will continue to motivate and dominate my work. There is some anecdotal evidence that the SEC may be struggling to ask “for the right information, in the most appropriate way.”  Several previous articles and three works in progress, including a forthcoming survey study on Form PF, evaluate if the SEC’s evaluation of systemic risk data in Form PF can facilitate regulators’ assessment of: “trends over time and identify risks as they are emerging.”  Another work in progress evaluates the effects of new Rule 506 (c) on the hedge fund industry.

HEDGE FUND REGULATION SYMPOSIUM


UNIVERSITY OF MINNESOTA LAW SCHOOL CORPORATE INSTITUTE

HEDGE FUND REGULATION SYMPOSIUM

Tuesday, November 5, at 3:15-5:15PM (Reception to follow)

University of Minnesota Law School Room 25

Applied for CLE Credits – 2 hours (No charge)

RSVP to melloh@umn.edu

 

US hedge fund regulation under the Dodd-Frank Act of 2010…European hedge fund regulation…legal and illegal use of nonpublic information for securities trading

PANELISTS: 

Tim O’Brien, General Counsel and Chief Compliance Officer, Pine River Capital Management L.P.

Richard W. Painter, S. Walter Richey Professor of Corporate Law, University of Minnesota Law School

Wulf A. Kaal, Associate Professor of Law, University of St. Thomas School of Law

AGENDA:

Panel 1:   Legal and Illegal Use of Nonpublic Information in Securities Trading

Not all trading on the basis of nonpublic information is illegal, but trading on the basis of misappropriated information is illegal in the US; so is trading on the basis of most nonpublic information about tender offers. Other countries have different approaches to insider trading laws and enforcement, and it can sometimes be confusing to determine which jurisdiction’s laws apply. Governments, international organizations and other entities sometimes selectively disclose nonpublic information to investors and in many, but not all instances, investors can legally take advantage of this information.  This panel will explore the difference between legal and illegal trading on nonpublic information as well as situations where the legality of trading is debatable. The panel will also discuss use by investors of expert networks and other consulting firms.

Panel 2:  Hedge Fund Regulation in US and Europe – Recent Developments and Projections   Both the US and Europe responded to the financial crisis of 2008 with extensive new regulation of investment funds and investment advisors, including many hedge funds.  This panel will discuss the impact of regulations adopted in the US pursuant to the Dodd-Frank Act of 2010.  The panel will also discuss developments under the European Union directive regulating alternative investment funds (“AIFs”) that was adopted in June 2011, supplemented in December 2012 by Level 2 implementing regulations, and further supplemented in February 2013 under Guidelines published by the European Securities and Markets Authority.

All three panelists will participate in both panels.  There will be a roundtable discussion format and participation by the audience will be strongly encouraged.

PANELIST BIOGRAPHIES:

Tim O’Brien is General Counsel and Chief Compliance Officer for Pine River Capital Management LLP in Minneapolis.  He is responsible for the legal and compliance functions at Pine River. Prior to joining Pine River in 2007, he served as Vice President and General Counsel of NRG Energy, Inc. from 2004 until 2006. He served as Deputy General Counsel of NRG Energy from 2000 to 2004 and Assistant General Counsel from 1996 to 2000. Prior to joining NRG, he was an associate at Sheppard Mullin in Los Angeles and San Diego, California. He received a BA in History from Princeton University in 1981 and a JD from the University of Minnesota Law School in 1986. Tim was admitted to the Pine River partnership in 2010.

Pine River Capital Management L.P. was founded in early 2002.  The firm was originally located in Pine River, Minnesota, and moved to Minneapolis in 2003 and then to Minnetonka in 2007.   Pine River opened research and trading offices in London in 2004, Hong Kong in 2007, San Francisco and New York in 2008, and Austin in early 2013. In the summer of 2010, Pine River opened a research office in Beijing and in 2012 the firm opened a research office in Shenzhen. The Minnetonka office remains its headquarters.

Pine River Capital Management L.P. became registered as a Commodity Pool Operator and a Commodity Trading Advisor with the US National Futures Association in May 2002. Pine River Capital Management (UK) Limited became authorized by the Financial Conduct Authority to manage investments in the UK in January 2004. Pine River Capital Management L.P. became registered as an investment advisor with the US Securities and Exchange Commission in January 2006. Pine River Capital Management (HK) Limited became licensed by the Securities and Futures Commission to manage assets in Hong Kong in March 2007. Pine River Capital Management L.P. became registered as a Foreign Institutional Investor in India in February 2008.

Richard W. Painter is the S. Walter Richey Professor of Corporate Law at the University of Minnesota Law School.   He has published extensively on financial services regulation, investment banking, insider trading and selective disclosure of nonpublic government information to hedge funds and other investors.

From February 2005 to July 2007, he was Associate Counsel to the President in the White House Counsel’s office, serving as the chief ethics lawyer for the President, White House employees and senior nominees to Senate-confirmed positions in the Executive Branch.  In 2002, he was instrumental in assuring passage of a key provision of the Sarbanes-Oxley Act requiring the SEC to issue rules of professional responsibility for securities lawyers that was based on earlier proposals he had made in law review articles and to the SEC.  Professor Painter has on five separate occasions provided invited testimony before committees of the U.S. House of Representatives or the U.S. Senate on securities litigation and/or the role of attorneys in corporate governance. He also testified as a defense witness in SEC. v. The Reserve Money Market Fund (SDNY, November 2012), a jury trial of an SEC enforcement action against the founders of the world’s oldest money market fund that ended with a defense verdict on all of the fraud counts.

Professor Painter received his B.A. from Harvard University and his J.D. from Yale University. Following law school, he clerked for Judge John T. Noonan Jr., of the United States Court of Appeals for the Ninth Circuit and later practiced at Sullivan & Cromwell in New York City and Finn Dixon & Herling in Stamford, Connecticut.

Wulf A. Kaal is a tenured associate professor of law at the University of St. Thomas School of Law.  He is a leading expert on hedge fund regulation in the United States and the European Union. He uses empirical methods to investigate the effects of financial regulation and the strategic behavior of private fund advisers. His theoretical research focuses on the use of finance and economic theory to analyze and inform financial and regulatory policy.

He has published more than two dozen articles in the United States and Europe. His study on the effects of hedge fund registration requirements under the Dodd-Frank Act has gained national attention and was covered in a Business Week article and in other journals.  He is the author of a book chapter on Investment Advisers in the Research Handbook on Corporate Law and Governance, published by Edward Elgar.

Before entering law teaching, Kaal was associated with Cravath, Swaine & Moore LLP in New York and Goldman Sachs in London.  He has published more than two dozen articles in the United States and Europe. He has also been a consultant to major corporations and hedge funds regarding various aspects of financial markets and regulation.  He received his Ph.d from the Humboldt University in Berlin, Germany, his M.B.A from Durham University in the United Kingdom, and his J.D. from the University of Illinois.

 

Presenting on “Hedge Fund Compliance Cost” at Canadian Law & Economics Association in Toronto

Presentation at the Canadian Law and Economics Association annual meeting  on September 29, 2013 in Toronto:  

The Impact of Compliance Cost of Financial Regulation ­- Evidence from

the Private Fund Industry

by

Wulf A. Kaal

Abstract 

A common complaint about financial regulation is that it predominantly affects smaller firms because the cost of compliance brings increasing returns to scale. Many studies have shown that an inverse relationship exists between the size of regulated firms and the per-unit cost of compliance.Anecdotal evidence suggests that Title IV of the Dodd-Frank Act, mandating hedge fund adviser registration and increased disclosures, affects mostly smaller hedge fund advisers. To estimate the effect of Title IV on smaller hedge fund advisers, this study evaluates survey data collected after the registration effective date for hedge fund advisers under Title IV.

The author finds no evidence of an inverse relationship between the size of regulated hedge fund advisers and the per-unit cost of compliance.The size of hedge fund advisers as measured by assets under management (AUM) is associated with the cost of Title IV compliance and other independent variables. These findings are inconsistent with the hypothesis that the cost of financial regulation affects smaller firms more than larger firms. Adviser size may not matter as much for policy adjustments and SEC rule making as the hedge fund industry claimed.

 

A Bright Future for the Hedge Fund Industry and its Impact on Policy Making

The Financial Times reports that hedge funds have transformed themselves and are increasingly influencing policy.

My own work provides some empirical support for these observations. My study “Hedge Fund Manager Registration under the Dodd Frank Act” shows that hedge fund managers are only mildly affected by unprecedented registration and disclosure obligations under the Dodd-Frank Act and will be able to grow their influence in future years.  This may have many significant policy implications.

Two additional empirical studies are forthcoming and should help narrow down the effects of Title IV on hedge fund managers. One study pertains to the effect of Title IV on hedge fund manager earnings (in a regression discontinuity design), the other study evaluates the effect of Title IV on smaller hedge fund advisers. Initial results are significant and have important policy implications.

Another study will evaluate the impact of the Alternative Investment Fund Managers (AIFM) Directive on the European Hedge Fund Industry.

Please see the executive summary and summary graphs for the first of these four studies (“Hedge Fund Manager Registration under the Dodd Frank Act”) below:

Executive Summary:  Most hedge fund managers are not altering the size of their funds to avoid Dodd-Frank Act requirements. Managers are also not altering their investing styles. Most of the new registration and disclosure requirements have not affected the returns for hedge fund investors. 

Only very few managers have changed their funds’ legal structure in response to Dodd-Frank Act requirements. Rather, hedge funds are adapting to the new requirements by outsourcing compliance work, hiring additional counsel, establishing new record-keeping policies, hiring additional staff, and changing marketing materials and investor communication.

Please see the summary graphs below:

Figone.onePlan a Strategic Response to Dodd-Frank
: A minority of respondents in the survey has planned a strategic response to the Dodd-Frank Act requirements. This suggests that the requirements in Dodd-Frank and the SEC regulations implementing these requirements are not perceived as materially changing the existing business and compliance model.


FigOne.TwoConsider Current Regulations to Determine AUM Size: A majority of respondents did not plan to change their assets under management in response to the new regulatory environment even though lowering the AUM below a certain threshold could exempt hedge fund advisers from the Dodd-Frank Act requirements.

 


Fig.One.TreeMost Common Actions Taken
: Hedge fund managers’ most common strategic responses in reaction to the registration and disclosure requirements under the Dodd-Frank Act include new record-keeping policies, the outsourcing of compliance work and changes in marketing materials. Most respondents indicated that they are addressing the requirements through compliance measures.

Figure-1_4Least Common Actions Taken
: It is not common for hedge fund managers to change of the funds’ legal structure or to lower the AUM to escape the application of the Dodd-Frank Act.

Figure-1_5Take Regulatory Regime into Account for AUM: 25 per cent of respondents plan on decreasing the AUM size of their funds to avoid the regulatory hassle. Others will increase current AUM size to cover expenses.

Figure-1_6

Desired AUM After Dodd-Frank
 Act:  
 The ideal AUM size for most respondents is somewhere between$150 million and $1.5 billion. However, existing regulation does not appear to have influenced funds’ choice regarding the size of their AUM. Choosing a particular AUM size is based on a fund’s strategy and its existing size.

Figure-1_7

Factors Influencing AUM Preference
:  Title IV  does not appear to have influenced fund managers’ choice regarding the size of their AUM. Choosing a particular AUM size is based on fund managers’ strategy and its existing size.

 

Private fund profitability after the enactment of the Dodd-Frank Act: While the new requirements do not appear to have change the earnings of hedge funds themselves, the profitability of the management company appears to be affected.

Dodd-Frank Affect Fund’s Earnings?


Figure-2_1Dodd-Frank Affect Management Company Profits?

Figure-2_2

Figure-2_3Cost of Compliance with Title IV: The cost of compliance for the hedge fund industry is somewhat moderate. 48 per cent of respondents did not incur more than $100,000.00 in compliance costs per year after the enactment of the Dodd-Frank Act.

 

 

 

 

Related articles

Summary of Recent Study on Hedge Fund Manager Registration under Title IV of the Dodd-Frank Act

Read the article at Cayman Financial Review

Read the full study

This article summarises the results of a recent survey of private fund managers.*

The study identifies the possible effects of hedge fund adviser registration under the Dodd-Frank Act and is intended to support policy makers in implementing new rules pertaining to the hedge fund industry. 

The study suggests that the registration and disclosure requirements under the Dodd-Frank Act and the SEC’s implementation of these requirements created several areas of concern for the hedge fund industry. Overall, however, the hedge fund industry appears to be adapting well to the regulatory environment after the enactment of the Dodd-Frank Act.

The Dodd-Frank Act marks the ending of the era of light-touch regulation and unsupervised hedge fund activities. Before the enactment of the Dodd-Frank Act, hedge fund managers were able to operate in financial markets with minimal regulatory supervision. 

The growth and importance of the hedge fund industry in worldwide financial markets may be attributable, at least in part, to the lack of regulatory oversight for more than half a century. The hedge fund industry thrived without regulatory supervision, generating higher returns and attracting an increasingly larger investor base. 

Given the success of the hedge fund industry in a light-touch regulatory environment, it is not surprising that the industry resisted the SEC’s past attempts to register hedge fund managers. When the SEC in December 2004 issued a final rule requiring hedge fund advisers to register under the Advisers Act1, the hedge fund industry strongly opposed the rule2. 

Two years later, in 2006, the United States District Court of Appeals for the District of Columbia in Goldstein v. SEC vacated the rule requiring registration of hedge fund managers as arbitrary3. 

Most registered hedge fund managers deregistered after the court issued its ruling in the Goldstein decision.

Title IV of the Dodd-Frank Act, entitled the Private Fund Investment Advisers Registration Act of 2010 (PFIARA), and SEC rules implementing the Act changed the regulatory landscape for the private fund industry. First and foremost, PFIARA authorised the SEC to promulgate rules requiring registration of private funds. The Act mandates hedge fund adviser registration so as to increase recordkeeping and disclosure4. 

Hedge fund manager registration under PFIARA, applies to any fund with more than $150 million assets under Management (AUM)5. 

Once registered, private fund managers are subject to enhanced disclosure requirements. Hedge fund managers are required to maintain records to avoid systemic risk6 and provide confidential reports related to systemic risk7. 

Information about the fund and the managers’ portfolio includes: the amount of AUM, the use of leverage, including off-balance sheet leverage, counterparty credit risk exposures, trading practices, trading and investment positions, valuation policies, side letters and other information deemed necessary8.

Methodology

In order to identify the possible impact of hedge fund adviser registration requirements under the Dodd-Frank Act, the study draws inferences based on a sample of investment advisers from a population of investment advisers registered in the United States. The author and four research assistants collected data by approaching 1264 private fund managers with a survey questionnaire. 

The survey asked private fund managers to describe the possible effects of hedge fund manager registration requirements under the Dodd-Frank Act. Respondents (n=94) answered questions in several categories, including: strategic responses to the Dodd-Frank Act requirements, cost of compliance, long-term effect of reporting and disclosure rules on the private fund industry, compliance measures, long-term effect of reporting and disclosure rules on private funds, effect of the regulatory regime on assets under management, and effect of the regulatory regime on profitability.

Executive summary

The results summarised below are the major findings of the first observational study conducted after the SEC’s registration effective date for hedge fund advisers, 30 March, 2012. The study will help support hedge fund advisers in the administrative management of their funds because it quantifies compliance costs, it evaluates compliance measures and it assesses fund managers’ strategic responses to the implementation of the Dodd-Frank Act. 

Other important findings of the study pertain to the implications of the private fund disclosure requirements under the Dodd-Frank Act and the possible long-term effects of hedge fund manager registration, including the effect on assets under management and profitability.

Strategic responses to Dodd-Frank

Hedge fund managers can implement a broad array of legal and strategic responses to address perceived concerns of new regulations. For instance, managers can change the legal structure of their funds and management companies, they can lower or increase the assets under management, or they can change the strategy pertaining to their funds.

As Figure 1.1 shows, a minority of respondents in the survey has planned a strategic response to the Dodd-Frank Act requirements. This suggests that the requirements in Dodd-Frank and the SEC regulations implementing these requirements are not perceived as materially changing the existing business and compliance model.

Plan a Strategic Response to Dodd-Frank
Figure 1.1

This finding is confirmed by Figure 1.2: a clear majority of respondents did not plan to change their assets under management in response to the new regulatory environment even though lowering the AUM below a certain threshold could exempt hedge fund advisers from the Dodd-Frank Act requirements.

Consider Current Regulations to Determine AUM Size
Figure 1.2

Figure 1.3 illustrates hedge fund managers’ most common strategic responses in reaction to the registration and disclosure requirements under the Dodd-Frank Act. Most respondents indicated that they are addressing the requirements through compliance measures. By contrast, Figure 1.4 shows that a change of the funds’ legal structure, lowering the AUM, and other changes to escape the application of the Dodd-Frank Act do not constitute common strategic responses.

Most Common Actions Taken
Figure 1.3

Least Common Actions Taken
Figure 1.4

Figure 1.5 shows that 25 per cent of respondents plan on decreasing the AUM size of their funds to avoid the regulatory hassle. Others will increase current AUM size to cover expenses.

Take Regulatory Regime into Account for AUM by
Figure 1.5

Figure 1.6 suggests that the ideal AUM size for most respondents is somewhere between $150 million and $1.5 billion. However, existing regulation does not appear to have influenced funds’ choice regarding the size of their AUM. Rather, figure 1.7 suggests that choosing a particular AUM size is based on a fund’s strategy and its existing size.

Desired AUM After Dodd-Frank
Figure 1.6

Factors Influencing AUM Preference
Figure 1.7

Private fund profitability after the enactment of the Dodd-Frank Act

A major concern of the hedge fund industry prior to the enactment of the Dodd-Frank Act pertained to the possible effect of new rules and regulations on privacy, proprietary trading positions, and profitability. Managers were concerned that a leak of sensitive data managers report to the SEC could affect their profitability, result in possible reverse-engineering of a fund’s strategy, and the detection of weaknesses that rival firms could exploit. 

Figure 2.1 illustrates managers’ responses pertaining to the profitability of their hedge funds and the effects of the Dodd-Frank Act on investors. While the new requirements do not appear to have affected the earnings of hedge funds, Figure 2.2 suggests that the profitability of the management company will be affected. Future research examining hedge fund performance after the enactment of the Dodd-Frank Act may help clarify if the tectonic shift in hedge fund regulation through the Dodd-Frank Act had a latent or delayed effect on hedge fund earnings9.

Dodd-Frank Affect Fund’s Earnings?
Figure 2.1

Dodd-Frank Affect Management Compnay Porfits?
 Figure 2.2

Another major concern of the hedge fund industry revolved around the possible cost of compliance. The industry and regulators have not addressed the possible consequences of compliance costs. A high level of compliance costs could make it more difficult for new hedge fund start-ups to enter the market and result in consolidation of larger funds. If the consolidation of hedge funds should increase systemic risk, Title IV of the Dodd-Frank Act could result in the exact opposite of Congress’s intent10.  

Figure 2.3 indicates that the cost of compliance for the hedge fund industry is somewhat moderate. 48 per cent of respondents did not incur more than $100,000.00 in compliance costs per year after the enactment of the Dodd-Frank Act.

Cost Required to Comply with Dodd-Frank
Figure 2.3

Conclusion and future research



Despite initial industry grumbling, the results of this study suggest that hedge fund advisers are taking the new regulatory burdens under the Dodd-Frank Act in stride. Most hedge fund managers are not altering the size of their funds to avoid Dodd-Frank Act requirements. Managers are also not altering their investing styles. Most of the new registration and disclosure requirements have not affected the returns for hedge fund investors. 

Very few managers have changed their funds’ legal structure in response to Dodd-Frank Act requirements. Rather, hedge funds are adapting to the new requirements by outsourcing compliance work, hiring additional counsel, establishing new record-keeping policies, hiring additional staff, and changing marketing materials and investor communication. 

Hedge funds should easily absorb the cost of these measures. There is some evidence, however, that smaller investment advisers could be disproportionally affected by the registration and disclosure requirements in the Dodd-Frank Act. Future research may help policy makers appreciate the effects of the regulatory regime on smaller fund advisers11.

There is also some anecdotal evidence that ambiguities in the SEC forms may enable fund managers to report data in disparate ways. Disparate data reporting could make it more difficult for the newly created Financial Stability Oversight Council (FSOC) to conduct a comparative and comprehensive assessment of systemic risk. The FSOC’s work could be further complicated by funds’ use of estimates and educated guesses in disclosing the required data to the SEC. Future research could help clarify whether FSOC and SEC d12.

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