The Coming Hedge Fund Regulation

I'm back from a couple of drinks with a key player in and around the hedge fund industry and also in and around Congress. Although he is not technically associated on paper with either, the sensitive nature of his position requires me to protect his identity.

My source tells me that the hedge fund industry understands that registration and regulation is coming. Their view is that it is inevitable and the goal is to limit damage. Two things worry them most, the possibility that somehow hedge fund offshore activities will be regulated, and the fear that individual states will take it upon themselves to regulate the industry.

The fear of regulation at the state level, and having to deal with possibly 50 different state regs, is pushing the industry toward calling for federal regulation as a method of getting out ahead of the states. With federal regulation, the hedge funds will then work at the state level to point out that state regulation would be redundant.

The hedge funders don't seem to have a ready answer for stopping attempts at regulating offshore regulations, if regulatory thought goes in that direction.

My source tells me that while the hedge funds will come under regulation the Private Equity people will probably escape regulation. The PE's are selling themselves as unimportant to the systemic life blood of the economy and thus there is no need to regulate them.

Ideally, hedge funders, making the best out of a bad situation, prefer some kind of registration that is similar to the investment advisory industry registration, which is a relatively non-probing registration.

Hedgies are actually in favor of raising the minimum that is required for an individual to participate in a hedge fund. I view this as an attempt to raise the barriers to entry into the industry by the gray beards. The longer you have been around, the easier it is to raise money. The newer players who in many cases may only be able to raise amounts near the minimum will thus not be able to meet new hurdles for entry into the business.

At this point hedgies are afraid to submit any kinds of talking points to Congress because they fear that anything they ask for in terms of legislation, Congress may simply turn around and do the exact opposite. The view among hedgies is that although AIG and the Madoff scandal had nothing to do with hedge funds, everytime these two names appear in the news, someone links them to hegde funds. "Including our president," said my source. Madoff "manged" individual accounts and AIG is essentially a complex insurance/finance firm.

As to who would oversee the industry, the question seems open. My source tells me that many in Congress are backing away from the Federal Reserve as super-regulator. Congressman Paul Kanjorski, a senior member of the House Financial Services Committee, has always been a skeptic about the Fed. My source tells me that even Congressman Barney Frank, the chairman of the House Financial Services Committee, is becoming suspicious of Fed activities and that he sees a problem with the Fed as super-regulator.

In general, congressmen are beginning to think through a super-regulator and fear that such a regulator will create the possibility that some congressmen will be sucked in to such a huge power source the way some were sucked into the vortex of Sallie Mae and Fannie Mae. And, thus, I guess bad publicty for their more low key scams.