Apr 10 2003



“The Committee shall come to order. Today, the Committee will be hearing from SEC Chairman William Donaldson regarding the hedge fund industry. The immediate reason for this hearing is to get a progress report on the ongoing SEC oversight investigation of the hedge fund industry. I hope that this hearing will shed some light on developments within an industry that has been the subject of a great deal of surmise and opinion, but much less in the way of objective analysis.”

“Despite the recent bear market, America remains a nation of investors. The internet, cable and satellite TV and a host of other technological innovations have made information regarding the marketplace available just about anywhere and anytime. We are all familiar with the trappings of Wall Street. But at a time when the floor of the New York Stock Exchange doubles as the set for a television show, and market analysts are TV personalities, hedge funds remain the last frontier, an unchartered area of our capital markets.”

“Historically, hedge funds have been an outlier in the world of functional regulation. These investment pools have been, to borrow Winston Churchill’s words regarding Russia, “a riddle wrapped in a mystery inside an enigma.” Hedge funds are not household names, and their managers have usually gone to great lengths to avoid public attention. Hedge funds operate in relative anonymity because they are limited partnerships, financed through private placements. Like all market participants, hedge funds are subject to the anti-fraud provisions of the federal securities law. But they are exempt from a regulatory regime like that applied to broker-dealers, investment advisors or publicly traded companies.”

“Most businesses are focused on their public image and branding; but hedge funds have not only avoided publicity, as privately placed offerings they are prohibited from advertising to the public. As private placements, hedge funds are the domain of extremely wealthy individuals and institutional investors. The securities laws deem that such investors have the acumen and negotiating power to fend for themselves to a degree that the ordinary investor can not. This is not a hedge fund-specific exemption.”

“Events of the recent past have attracted unwanted attention to these funds. The 1998 collapse of Long Term Capital Management put hedge funds on the front pages of the business news. In the intervening years, hedge funds have continued to attract media attention. Since the beginning of the recent bear market, much of that attention has focused on the “retailization” of hedge funds, the explosive growth in the number of hedge funds, and an equally explosive growth in the number of hedge fund closings.”

“During the recent bear market it appears that hedge funds have had positive, if not spectacular results. However, positive returns have been enough to attract a flight of capital from more traditional market investments. And the generous fees that hedge fund managers earn has been enough to attract many of the best money managers. The desire to retain talent has led many mutual funds to establish affiliated hedge funds.”

“As we consider these issues today, I believe it is important to remain mindful of the important role that hedge funds continue to play in our capital markets. Hedge funds are a liquidity source that permits capital to seek higher rewards regardless of the overall market environment. They can provide expert management for patient capital that understands, and can bear the risks associated with seeking higher returns. However, when these funds are made available to less sophisticated investors through mutual funds, investor protection concerns arise that deserve careful consideration. These so-called “funds of funds” must provide sufficient transparency and protection for their customers.”

“The growth of an indirect retail market and other recent trends in the industry pose a number of investor protection issues. For instance, are retail investors receiving sufficient disclosure regarding their investments in so-called “funds-of-funds”? Is the conflict posed by co-management of hedge funds and mutual funds being properly managed? Are any hedge funds using the opaqueness of the private placement to misuse or mismanage funds entrusted to them? The Committee looks forward to the answers to this and other questions.”

“I commend the SEC for its efforts to undertake this important and timely review of the hedge fund industry, and look forward to Chairman Donaldson’s testimony today.”