Tag Archives: hedge fund regulation

Karl Cole-Frieman Quoted on Expert Networks

Insider Trading Remains Popular Topic in Hedge Fund Regulation

Insider trading by hedge funds and the use of expert networks has been a hot compliance topic in 2010 and 2011. The topic remains in the spotlight as Massachusetts recently passed new expert network regulations. Under the new regulations, registered investment advisers in Massachusetts will be required to maintain certain records with respect to transactions with expert network firms. [Note: we will be detailing these and other regulations recently adopted by Massachusetts which will become effective as of December 1, 2011.]

Karl Cole-Frieman was quoted by Law360.com in an article on the new Massachusetts expert network regulations (subscription required). In the article Karl is attributed with providing information on the effect the regulations may have on expert networking firms, how expert networking firms may respond to the Massachusetts regulations and how hedge fund managers may modify their compliance programs to adhere to Massachusetts (and potentially other state) regulations.

We expect to see more states come out with similar laws and we will provide updates and more information as appropriate.


Karl Cole-Frieman is a managing partner at Cole-Frieman & Mallon LLP and he provides advice to fund managers with respect to insider trading and the use of expert network firms. He can be reached

at 415-352-2300 or through our contact form.


CFTC Head Addresses Futures Industry in Chicago

Futures Industry Association Annual Expo

CFTC Chairman Gary Gensler today spoke at the Futures Industry Association’s annual expo in Chicago. While most of the Chairman’s speech  focused on the proposed regulation of the OTC derivatives markets, Chairman Gensler also discussed the recent SEC and CFTC Harmonization report. As you can imagine, Gensler is for increasing regulation of the entire financial markets. Below I have included some of the more interested quotes which can be found in the text of the speech text of Chairman Gensler’s speech.

The CTA Expo was going on as well during this time and I will be writing more articles on the speakers at this conference over the next few days.


Both of the committees’ bills include three important elements of regulatory reform: First, they require swap dealers and major swap participants to register and come under comprehensive regulation. This includes capital standards, margin requirements, business conduct standards and recordkeeping and reporting requirements. Second, the bills require that dealers and major swap participants bring their clearable swaps into central clearinghouses. Third, they require dealers and major swap participants to use transparent trading venues for their clearable swaps.

The challenge remains, though, determining which transactions should be covered by these reforms. I believe that we must bring as many transactions under the regulatory umbrella as possible. This will best accomplish the two principal goals of reform: lowering risk to the American public and promoting transparency of the markets.


To promote market transparency, all standardized OTC products should be moved onto regulated exchanges or trade execution facilities. This is the best way to reduce information deficits for participants in these markets. Transparency greatly improves the functioning of the existing securities and futures markets. We should shine the same light on the swaps markets. Increasing transparency for standardized derivatives should enable both large and small end-users to obtain better pricing on standard and customized products.


Some have articulated a false choice between stronger regulation on the one hand and a free market on the other. Rules improve markets, however, by enhancing efficiency and integrity. Traffic lights require you to stop your car, but they also ensure that traffic is orderly and efficient. They reduce risks for every person on the highway. Similarly, this country’s markets work best with clear rules of the road.


Last year’s crisis also highlighted the need for regulators to change. In that regard, the CFTC last week released a joint report with the SEC to bring greater consistency, where appropriate, to our regulatory approaches. While the missions of the CFTC and the SEC may differ, our goal is the same: to protect the public, enhance market integrity and promote transparency. In preparing our report, we set turf aside and focused on those changes that would best benefit the markets and the American people.

We jointly made 20 recommendations where we can change our statutes and regulations to enhance both agencies’ enforcement powers, strengthen market and intermediary oversight and facilitate greater operational coordination.


Other related hedge fund law articles include:

Hedge Fund Regulation IT Solutions

Technology Solutions for Registered Hedge Fund Managers


It is the final quarter of this year’s political season and it has become clear that the earlier clamor for hedge fund registration has been overshadowed by larger political issues – namely health care legislation and the cap and trade bill.  Recent events, however, have shown that the registration issue is not dead and the venture capital industry has been able to potentially secure an exemption from the registration provisions. Even though we don’t know where regulation will take us in the next 6 to 18 months, it is likely that many hedge fund managers will need to institute compliance and IT programs as a result of forthcoming laws and regulations.

The article below, submitted by Meyer Ben-Reuven, CEO of Chelsea Technologies, details some issues which managers will need to be ready to handle once legislation and regulations go into effect.  State registered investment advisors should take note as they may already be required (under state law) to maintain such compliance programs.


How is President Obama’s New Hedge Fund Regulation Plan affecting you?
By Meyer Ben-Reuven, CEO Chelsea Technologies

The challenging question Hedge Fund Managers should ask themselves is what should they be doing to be compliant with President Obama’s Hedge Fund Regulation Plan?  There are many questions and many tasks to accomplish, but most important is to understand the main points of the plan, what needs to be done and what are the costs associated.  In this paper I present you with a summary of the President’s plan and what a Chief Compliance Officer needs to face in conjunction with the IT department to be compliant with regulations.  Costs are important, but I will keep them away from this paper.

Obama’s New Hedge Fund Regulation Plan

In June 2009, President Obama presented a proposal for new regulations that affect Hedge Funds and fund managers.  The most important part of this new regulation will be to require Hedge Fund, Private Equity, and VC Fund Managers to register with the SEC as investment advisors.

Although it is a proposal, all fund managers will have to start thinking about the re-registration and the process to keep the fund compliant.

The plan’s 5 main goals are:

  1. Promote robust supervision and regulation of financial firms.
  2. Establish comprehensive supervision and regulation of financial markets.
  3. Propose comprehensive regulation of all OTC derivatives.
  4. Protect customers and investors from financial abuse.
  5. Raise international regulatory standards and improve international cooperation.

The idea is to require advisers to report financial information on their fund and its management and thus have the ability to assess whether the fund poses a threat to the stability of the financial system and at the same time strengthen investor protection.

The specific goals regarding hedge funds are as follows:

  • Data collection
  • SEC should conduct regular, periodic examinations of hedge funds
  • Reporting AUM and other fund metrics to the SEC
  • SEC would have ability to assess whether the fund or fund family is so large, highly leveraged, or interconnected that it poses a threat to financial stability

How will IT Departments have to help keep the funds within regulation rules?

As of February 2006, Hedge Fund Advisors were obliged to comply with SEC Rule 203(b)(3)-2 requiring registration under the Investment Advisor Act.   Under these rules, the Hedge Funds were advised to retain all internal and external email and IM business communications.  In June 2006, the Goldstein ruling against the SEC pushed several funds to de-register.  With the failure of the financial system since the end of 2007, the new administration has been poised to regulate the industry more than ever.

What needs to be done?

  1. Take a look at all the ways communications are conducted in the fund
  2. What are the devices used to communicate
  3. Always be on the lookout for new technologies

Afterwards, insure you have control over the different communication methods.  As stated, all electronic communication in and out of the fund has to be retained for future review.  This means that if it cannot be controlled and retained, it must be prohibited.

All internal rules have to be specified in IT policies and procedures, otherwise no one can be held accountable.

The following is how data needs to be archived for SEC purpose audits:

  1. Incoming/Outgoing Data must be kept in its original form
  2. Data has to be easily retrievable and searchable
  3. Data has to have a date and time stamp
  4. Data has to be retained in the main office for first 2 years
  5. Data has to be retained for 5 years
  6. Data has to be put into tamper proof media (meaning non-rewritable and non-erasable)
  7. Data has to be stored in a secondary backup location (preferably away from the same grid)
  8. Be able to produce data promptly (within hours)
  9. Be able to provide data in its original format in either view or print form
  10. Implement annual review of the system

It is highly recommended that data be tested for integrity including testing retrieval and searching, as well as accuracy.  The test should be conducted on a yearly basis, but better if on a more frequent basis.
Although the IT department is in charge of conducting the process, it is ultimately the Chief Compliance Officer who is responsible for this area.  The Chief Compliance Officer needs to dictate the test frequency as well as to advise everyone in the firm about the policies and make sure everyone understands the consequences of failure to comply.

All these internal policies have to be in writing and any violations have to be documented and fixed.  The regular testing and reviews have to be documented and be ready for presentation in case of an audit.


What are the different communication venues that exist and can be controlled and thus archived?

  1. Email and IM from Exchange
  2. Email and IM from Bloomberg and Reuters
  3. Blackberry archiving of Pin-to-Pin , SMS, Call Detail logs
  4. E-Faxes
  5. Blogs
  6. Chat Rooms
  7. Message Boards
  8. Twitter
  9. Facebook
  10. LinkedIn

Since all of the above require certain technologies and software for archiving and retaining, you have to make an effort to comply with the regulations or otherwise prohibit the usage of such technologies in the work place.

How do you implement compliance?

There are two schools of thought to achieve compliance:

  1. Build an in-house system
  2. Use a third party system

The in-house system is more complex and often requires a larger upfront investment to build and maintain.  Keep in mind you will have to have the following:

  1. Servers, storage, and software
  2. Backup Servers, storage, and software in a location out of the main location grid
  3. Replication system
  4. Maintain both the main and backup location

The responsibility and costs can escalate, but depending on the size of the firm, it might be the most cost efficient.

The third party systems, which have built an infrastructure that is scalable, keep on growing as more clients join their list.  The time to implement is a fraction of building an in-house system.  Depending on the third party provider, there are several ways of getting the data:

  1. Have the data arrive to the email server and from there delivered to the third party provider
  2. Have the data arrive to the third party provider and then to the email server

Both methods of delivery have issues of their own.  The first method requires you to be diligent about monitoring the email flow and ensure data is routed to the archiving provider – the responsibility is shifted completely to you.  The second method, where the provider requires the email to be routed through their system before it arrives to your server, usually poses a different challenge where emails might get delayed at the provider.

If you decide on any of the above systems, you should try to utilize an external anti-spam solution to keep your storage usage to a minimum as well as to make sure that non-account emails do not reach your email server.  These measures will keep all spam from being part of your retention data.

References and information used from the following sources: Global Relay, Zantaz, LiveOffice, NextPage, Hedge Fund Law Blog


Bart Mallon, Esq. of Cole-Frieman & Mallon LLP runs Hedge Fund Law Blog.  Mr. Mallon’s legal practice is devoted to helping emerging and start up hedge fund managers successfully launch a hedge fund.  If you are a hedge fund manager who is looking to start a hedge fund or if you are a current hedge fund manager with questions about ERISA, please contact us or call Mr. Mallon directly at 415-868-5345.  Other related hedge fund law articles include:

SEC Budget to Double Under Schumer Proposal

Embarrassed Agency Would Get Much Needed Funding

“The SEC’s failure to catch Bernie Madoff shows a level of incompetence unseen since FEMA’s handling of Hurricane Katrina” — Charles Schumer

To say that the SEC is or should be embarrassed about the Madoff scandal is an understatement (please see our most recent discussion on the SEC and Madoff).  However, we have to recognize that the SEC has always been (and potentially always will be) hampered by a limited government budget.  Budget size affects the ability of the SEC to be an effective enforcer in a number of key ways – not the least of which is the SEC’s (in)ability to train and retain staff who are able to understand the nuance and intricacies of the investment management industry.  The budget issue may soon become a non-issue if a proposal by Democratic Senator Charles Schumer makes its way through congress.  The Schumer proposal would provide the SEC with badly needed additional funding by allowing the agency to collect fees from the institutions it oversees.  According to Schumer’s press release, reprinted in full below, “In 2007, though the SEC brought in $1.54 billion in fees, it secured just $881.6 million in funding. Had the agency simply been able to hold onto all the fees it collected, it would have represented a 75 percent increase over the budget it was allotted through the appropriations process.”

We fully stand behind the Schumer proposal and believe that the SEC needs significantly more funding (than it currently receives) in order to do its job effectively.  Additional funding is also needed because of the likely increase of the scope of the SEC’s oversight responsibilities.  As we have reported before President Obama is calling for increased financial regulation and members of the Senate and Congress have been quick to propose a handful of bills which would completely burden the SEC if it was not appropriated more funds.  We also would like to point out that the CFTC has similar budget concerns and should also be appropratiated more funds.

We urge Congress to move forward with the Schumer proposal and to pass a similar bill for the benefit of the CFTC.


September 3, 2009


Yesterday’s Inspector General Report Faulted SEC
Staff’s Lack of Expertise and Experience For Failure To Discover Madoff Ponzi Scheme

Schumer’s Proposal Would Give SEC Access To Millions In Badly-Needed Funds To Recruit And Retain Higher-Caliber Examiners

Schumer Bill Would Treat Investor Protection Agency Like Fed and FDIC, Which are Already Allowed To Keep Fees They Collect

On the heels of an explosive independent report that blamed the failure to catch Bernie Madoff’s fraud scheme on widespread incompetence at the Securities and Exchange Commission, U.S. Senator Charles E. Schumer (D-NY) announced Thursday that he is drafting legislation to allow the agency to keep all of the fees it collects so it can afford to recruit and retain better-trained personnel.

Schumer’s proposal, to be introduced when Congress returns to session next week, would, on average, bolster the SEC’s budget by hundreds of millions on an annual basis, enabling the agency to attract professionals with the expertise required to uncover complex financial fraud. In recent years, the size of the financial markets has grown rapidly while the SEC’s budget has remained essentially flat. The new funding scheme Schumer is proposing would treat the SEC in the same way as Federal Reserve and the Federal Deposit Insurance Corporation, both of which are funded through fees it collects from institutions it oversees.

SEC Chairman Mary Schapiro has already signaled her support for Schumer’s proposal.

“The SEC’s failure to catch Bernie Madoff shows a level of incompetence unseen since FEMA’s handling of Hurricane Katrina. It is clear the SEC needs a bigger, more reliable funding stream so it can retain and recruit the top talent that has fled the agency of late,” Schumer said. “Under the current system, the agency’s rank-and-file personnel are struggling to keep up with the more sophisticated actors in the market. We cannot keep starving the SEC’s budget or the agency will remain a shadow of its former self.”

Schumer’s proposal comes after the SEC released a damning report by the Inspector General yesterday. According to a summary of the report, the SEC had enough evidence against Madoff to merit an investigation into the dealings of his investment firm, but the agency simply didn’t see what was happening right in front of them. The report repeatedly cites the lack of experience and expertise of the SEC personnel assigned to investigate Madoff, finding that they “failed to appreciate the significance of the analysis” in the complaints about Madoff and “failed to follow up on inconsistencies.”

Schumer said the agency’s ability to retain experienced personnel is an ongoing problem since Wall Street firms are increasingly able to lure the agency’s experts with higher salaries. Schumer said the SEC’s chronic under-funding must be addressed in a comprehensive way. Currently, the SEC raises millions more dollars every year in registration and transaction fees (not including enforcement penalties or settlements) than it is allocated through the appropriations process, but its budget is limited to the amount approved by Congress.  In 2007, though the SEC brought in $1.54 billion in fees, it secured just $881.6 million in funding. Had the agency simply been able to hold onto all the fees it collected, it would have represented a 75 percent increase over the budget it was allotted through the appropriations process.

The SEC is one of only two financial regulators in the U.S. that must go through the annual Congressional appropriations process.  U.S. banking regulators such as the Federal Reserve and the FDIC, on the other hand, can use what they collect in fees, deposit insurance and interest income to fund their operations.

Under Schumer’s proposal, the SEC will fund its own operations by using the transaction and registration fees it collects in place of a Congressionally-mandated budget.  Self-funding will give the SEC access to millions more than is allocated through the Congressional appropriations process. Shapiro has suggested that hiring hundreds of new employees over the next few years for the Division of Enforcement and the Office of Compliance, Inspection, and Examination will give the SEC the human and technological resources it needs to keep up with a vast and expanding market.

The SEC’s staff of approximately 3,650 oversees 35,000 entities.  Securities trading volume has increased 261% between 2003 and 2008, but the SEC staff grew only 15% over that period of time.  The number of registered investment advisors has grown by 47%, and the assets they manage have increased by 105%.  Meanwhile, the SEC examination staff charged with overseeing this portion of the financial system has grown by only 13% in that same time.  The number of tips and complaints received by the SEC has increased by 146%, but the enforcement staff has expanded by only 23%.  The SEC does not have the technology to track such a large market with so many players, and currently the SEC has limited capabilities to analyze data and identify market and trading risk.


Other hedge fund law articles related to increased hedge fund regulation:

Outstanding Congressional Bills increasing financial regulation:

Bart Mallon, Esq. runs hedge fund law blog and has written most all of the articles which appear on this website.  Mr. Mallon’s legal practice is devoted to helping emerging and start up hedge fund managers successfully launch a hedge fund.  If you are a hedge fund manager who is looking to start a hedge fund, please call Mr. Mallon directly at 415-296-8510.

Obama on Financial Reform

President Discusses Future Financial Regulations in Advance of G20

Earlier today President Obama gave a speech in New York discussing the administration’s future plan for greater regulation of the financial markets in the wake of the financial crisis of 2008/2009.  Speaking strongly the President said:

So I want everybody here to hear my words:  We will not go back to the days of reckless behavior and unchecked excess that was at the heart of this crisis, where too many were motivated only by the appetite for quick kills and bloated bonuses.

And we intend to pass regulatory reform through Congress.

Of course no political speech about the financial crisis will fail to take a swipe at the hedge fund industry.  Obama took this opportunity to say that hedge funds “can operate outside of the regulatory system altogether.” Oft-repeated statements like these not only grossly mischaracterize the current regulatory system, but also unjustly serve to cast hedge funds as a progenitors of the financial crisis. [HFLB Note to President Obama – if you give me a call I am happy to give you a brief overview of how hedge funds are currently regulated under the securities laws.]

While there is really nothing new in this speech, it does drive home that increased financial regulation is likely coming soon.  I have reprinted the entire speech below and it can also be found here.



Office of the Press Secretary

For Immediate Release
September 14, 2009


Federal Hall
New York, New York

11:59 A.M. EDT

THE PRESIDENT:  Thank you very much.  It is wonderful to be back in New York after having just been here last week.  It is a beautiful day and we have some extraordinary guests here in the Hall today.  I just want to mention a few.

First of all from my economic team, somebody who I think has done extraordinary work on behalf of all Americans and has helped to strengthen our financial system immeasurably, Secretary Tim Geithner — please give him a big round of applause.  (Applause.)  Somebody who is continually guiding me and keeping me straight on the numbers, the chair of the Council of Economic Advisers, Christina Romer is here.  (Applause.)  We have an extraordinary economic recovery board and as chairman somebody who knows more about the financial markets and the economy generally than just about anybody in this country, Paul Volcker.  Thank you, Paul.  (Applause.)  The outstanding mayor of the city of New York, Mr. Michael Bloomberg.  (Applause.)  We have Assembly Speaker Sheldon Silver is here, as well; thank you.  (Applause.)

We have a host of members of Congress, but there’s one that I have to single out because he is going to be helping to shape the agenda going forward to make sure that we have one of the strongest, most dynamic, and most innovative financial markets in the world for many years to come, and that’s my good friend, Barney Frank.  (Applause.)  I also want to thank our hosts from the National Park Service here at Federal Hall and all the other outstanding public officials who are here.

Thanks for being here.  Thank you for your warm welcome.  It’s a privilege to be in historic Federal Hall.  It was here more than two centuries ago that our first Congress served and our first President was inaugurated.  And I just had a chance to glance at the Bible upon which George Washington took his oath.  It was here, in the early days of the Republic, that Hamilton and Jefferson debated how best to administer a young economy and ensure that our nation rewarded the talents and drive of its people.  And two centuries later, we still grapple with these questions — questions made more acute in moments of crisis.

It was one year ago today that we experienced just such a crisis.  As investors and pension-holders watched with dread and dismay, and after a series of emergency meetings often conducted in the dead of the night, several of the world’s largest and oldest financial institutions had fallen, either bankrupt, bought, or bailed out:  Lehman Brothers, Merrill Lynch, AIG, Washington Mutual, Wachovia.  A week before this began, Fannie Mae and Freddie Mac had been taken over by the government.  Other large firms teetered on the brink of insolvency.  Credit markets froze as banks refused to lend not only to families and businesses, but to one another.  Five trillion dollars of Americans’ household wealth evaporated in the span of just three months.  That was just one year ago.

Congress and the previous administration took difficult but necessary action in the days and months that followed.  Nonetheless, when this administration walked through the door in January, the situation remained urgent.  The markets had fallen sharply; credit was not flowing.  It was feared that the largest banks — those that remained standing — had too little capital and far too much exposure to risky loans.  And the consequences had spread far beyond the streets of lower Manhattan.  This was no longer just a financial crisis; it had become a full-blown economic crisis, with home prices sinking and businesses struggling to access affordable credit, and the economy shedding an average of 700,000 jobs every single month.

We could not separate what was happening in the corridors of our financial institutions from what was happening on the factory floors and around the kitchen tables.  Home foreclosures linked those who took out home loans and those who repackaged those loans as securities.  A lack of access to affordable credit threatened the health of large firms and small businesses, as well as all those whose jobs depended on them.  And a weakened financial system weakened the broader economy, which in turn further weakened the financial system.

So the only way to address successfully any of these challenges was to address them together.  And this administration, under the outstanding leadership of Tim Geithner and Christy Romer and Larry Summers and others, moved quickly on all fronts, initializing a financial — a financial stability plan to rescue the system from the crisis and restart lending for all those affected by the crisis.  By opening and examining the books of large financial firms, we helped restore the availability of two things that had been in short supply:  capital and confidence.  By taking aggressive and innovative steps in credit markets, we spurred lending not just to banks, but to folks looking to buy homes or cars, take out student loans, or finance small businesses.  Our home ownership plan has helped responsible homeowners refinance to stem the tide of lost homes and lost home values.

And the recovery plan is providing help to the unemployed and tax relief for working families, all the while spurring consumer spending.  It’s prevented layoffs of tens of thousands of teachers and police officers and other essential public servants.  And thousands of recovery projects are underway all across America, including right here in New York City, putting people to work building wind turbines and solar panels, renovating schools and hospitals, repairing our nation’s roads and bridges.

Eight months later, the work of recovery continues.  And though I will never be satisfied while people are out of work and our financial system is weakened, we can be confident that the storms of the past two years are beginning to break.  In fact, while there continues to be a need for government involvement to stabilize the financial system, that necessity is waning.  After months in which public dollars were flowing into our financial system, we’re finally beginning to see money flowing back to taxpayers.  This doesn’t mean taxpayers will escape the worst financial crisis in decades entirely unscathed.  But banks have repaid more than $70 billion, and in those cases where the government’s stakes have been sold completely, taxpayers have actually earned a 17 percent return on their investment.  Just a few months ago, many experts from across the ideological spectrum feared that ensuring financial stability would require even more tax dollars.  Instead, we’ve been able to eliminate a $250 billion reserve included in our budget because that fear has not been realized.

While full recovery of the financial system will take a great deal more time and work, the growing stability resulting from these interventions means we’re beginning to return to normalcy.  But here’s what I want to emphasize today:  Normalcy cannot lead to complacency.

Unfortunately, there are some in the financial industry who are misreading this moment.  Instead of learning the lessons of Lehman and the crisis from which we’re still recovering, they’re choosing to ignore those lessons.  I’m convinced they do so not just at their own peril, but at our nation’s.  So I want everybody here to hear my words:  We will not go back to the days of reckless behavior and unchecked excess that was at the heart of this crisis, where too many were motivated only by the appetite for quick kills and bloated bonuses.  Those on Wall Street cannot resume taking risks without regard for consequences, and expect that next time, American taxpayers will be there to break their fall.

And that’s why we need strong rules of the road to guard against the kind of systemic risks that we’ve seen.  And we have a responsibility to write and enforce these rules to protect consumers of financial products, to protect taxpayers, and to protect our economy as a whole.  Yes, there must — these rules must be developed in a way that doesn’t stifle innovation and enterprise.  And I want to say very clearly here today, we want to work with the financial industry to achieve that end.  But the old ways that led to this crisis cannot stand.  And to the extent that some have so readily returned to them underscores the need for change and change now.  History cannot be allowed to repeat itself.

So what we’re calling for is for the financial industry to join us in a constructive effort to update the rules and regulatory structure to meet the challenges of this new century.  That is what my administration seeks to do.  We’ve sought ideas and input from industry leaders and policy experts, academics, consumer advocates, and the broader public.  And we’ve worked closely with leaders in the Senate and the House, including not only Barney, but also Senators Chris Dodd and Richard Shelby, and Barney is already working with his counterpart, Sheldon [sic] Bachus.  And we intend to pass regulatory reform through Congress.

And taken together, we’re proposing the most ambitious overhaul of the financial regulatory system since the Great Depression.  But I want to emphasize that these reforms are rooted in a simple principle:  We ought to set clear rules of the road that promote transparency and accountability.  That’s how we’ll make certain that markets foster responsibility, not recklessness.  That’s how we’ll make certain that markets reward those who compete honestly and vigorously within the system, instead of those who are trying to game the system.

So let me outline specifically what we’re talking about.  First, we’re proposing new rules to protect consumers and a new Consumer Financial Protection Agency to enforce those rules.  (Applause.)  This crisis was not just the result of decisions made by the mightiest of financial firms.  It was also the result of decisions made by ordinary Americans to open credit cards and take on mortgages.  And while there were many who took out loans they knew they couldn’t afford, there were also millions of Americans who signed contracts they didn’t fully understand offered by lenders who didn’t always tell the truth.

This is in part because there is no single agency charged with making sure that doesn’t happen.  That’s what we intend to change.  The Consumer Financial Protection Agency will have the power to make certain that consumers get information that is clear and concise, and to prevent the worst kinds of abuses.  Consumers shouldn’t have to worry about loan contracts designed to be unintelligible, hidden fees attached to their mortgage, and financial penalties — whether through a credit card or a debit card — that appear without warning on their statements.  And responsible lenders, including community banks, doing the right thing shouldn’t have to worry about ruinous competition from unregulated competitors.

Now there are those who are suggesting that somehow this will restrict the choices available to consumers.  Nothing could be further from the truth.  The lack of clear rules in the past meant we had the wrong kind of innovation:  The firm that could make its products look the best by doing the best job of hiding the real costs ended up getting the business.  For example, we had “teaser” rates on credit cards and mortgages that lured people in and then surprised them with big rate increases.  By setting ground rules, we’ll increase the kind of competition that actually provides people better and greater choices, as companies compete to offer the best products, not the ones that are most complex or the most confusing.

Second, we’ve got to close the loopholes that were at the heart of the crisis.  Where there were gaps in the rules, regulators lacked the authority to take action.  Where there were overlaps, regulators often lacked accountability for inaction.  These weaknesses in oversight engendered systematic, and systemic, abuse.

Under existing rules, some companies can actually shop for the regulator of their choice — and others, like hedge funds, can operate outside of the regulatory system altogether.  We’ve seen the development of financial instruments — like derivatives and credit default swaps — without anyone examining the risks, or regulating all of the players.  And we’ve seen lenders profit by providing loans to borrowers who they knew would never repay, because the lender offloaded the loan and the consequences to somebody else.  Those who refused to game the system are at a disadvantage.

Now, one of the main reasons this crisis could take place is that many agencies and regulators were responsible for oversight of individual financial firms and their subsidiaries, but no one was responsible for protecting the system as the whole — as a whole.  In other words, regulators were charged with seeing the trees, but not the forest.  And even then, some firms that posed a “systemic risk” were not regulated as strongly as others, exploiting loopholes in the system to take on greater risk with less scrutiny.  As a result, the failure of one firm threatened the viability of many others.  We were facing one of the largest financial crises in history, and those responsible for oversight were caught off guard and without the authority to act.

And that’s why we’ll create clear accountability and responsibility for regulating large financial firms that pose a systemic risk.  While holding the Federal Reserve fully accountable for regulation of the largest, most interconnected firms, we’ll create an oversight council to bring together regulators from across markets to share information, to identify gaps in regulation, and to tackle issues that don’t fit neatly into an organizational chart.  We’ll also require these financial firms to meet stronger capital and liquidity requirements and observe greater constraints on their risky behavior.  That’s one of the lessons of the past year.  The only way to avoid a crisis of this magnitude is to ensure that large firms can’t take risks that threaten our entire financial system, and to make sure that they have the resources to weather even the worst of economic storms.

Even as we’ve proposed safeguards to make the failure of large and interconnected firms less likely, we’ve also created — proposed creating what’s called “resolution authority” in the event that such a failure happens and poses a threat to the stability of the financial system.  This is intended to put an end to the idea that some firms are “too big to fail.”  For a market to function, those who invest and lend in that market must believe that their money is actually at risk.  And the system as a whole isn’t safe until it is safe from the failure of any individual institution.

If a bank approaches insolvency, we have a process through the FDIC that protects depositors and maintains confidence in the banking system.  This process was created during the Great Depression when the failure of one bank led to runs on other banks, which in turn threatened the banking system as a whole.  That system works.  But we don’t have any kind of process in place to contain the failure of a Lehman Brothers or AIG or any of the largest and most interconnected financial firms in our country.

And that’s why, when this crisis began, crucial decisions about what would happen to some of the world’s biggest companies — companies employing tens of thousands of people and holding trillions of dollars of assets — took place in hurried discussions in the middle of the night.  That’s why we’ve had to rely on taxpayer dollars.  The only resolution authority we currently have that would prevent a financial meltdown involved tapping the Federal Reserve or the federal treasury.  With so much at stake, we should not be forced to choose between allowing a company to fail into a rapid and chaotic dissolution that threatens the economy and innocent people, or, alternatively, forcing taxpayers to foot the bill.  So our plan would put the cost of a firm’s failures on those who own its stock and loaned it money.  And if taxpayers ever have to step in again to prevent a second Great Depression, the financial industry will have to pay the taxpayer back — every cent.

Finally, we need to close the gaps that exist not just within this country but among countries.  The United States is leading a coordinated response to promote recovery and to restore prosperity among both the world’s largest economies and the world’s fastest growing economies.  At a summit in London in April, leaders agreed to work together in an unprecedented way to spur global demand but also to address the underlying problems that caused such a deep and lasting global recession.  And this work will continue next week in Pittsburgh when I convene the G20, which has proven to be an effective forum for coordinating policies among key developed and emerging economies and one that I see taking on an important role in the future.

Essential to this effort is reforming what’s broken in the global financial system — a system that links economies and spreads both rewards and risks.  For we know that abuses in financial markets anywhere can have an impact everywhere; and just as gaps in domestic regulation lead to a race to the bottom, so do gaps in regulation around the world.  What we need instead is a global race to the top, including stronger capital standards, as I’ve called for today.  As the United States is aggressively reforming our regulatory system, we’re going to be working to ensure that the rest of the world does the same.  And this is something that Secretary Geithner has already been actively meeting with finance ministers around the world to discuss.

A healthy economy in the 21st century also depends on our ability to buy and sell goods in markets across the globe.  And make no mistake, this administration is committed to pursuing expanded trade and new trade agreements.  It is absolutely essential to our economic future.  And each time that we have met — at the G20 and the G8 — we have reaffirmed the need to fight against protectionism.  But no trading system will work if we fail to enforce our trade agreements, those that have already been signed.  So when — as happened this weekend — we invoke provisions of existing agreements, we do so not to be provocative or to promote self-defeating protectionism, we do so because enforcing trade agreements is part and parcel of maintaining an open and free trading system.

And just as we have to live up to our responsibilities on trade, we have to live up to our responsibilities on financial reform as well.  I have urged leaders in Congress to pass regulatory reform this year and both Congressman Frank and Senator Dodd, who are leading this effort, have made it clear that that’s what they intend to do.  Now there will be those who defend the status quo — there always are.  There will be those who argue we should do less or nothing at all.  There will be those who engage in revisionist history or have selective memories, and don’t seem to recall what we just went through last year.  But to them I’d say only this:  Do you really believe that the absence of sound regulation one year ago was good for the financial system?  Do you believe the resulting decline in markets and wealth and unemployment, the wrenching hardship that families are going through all across the country, was somehow good for our economy?  Was that good for the American people?

I have always been a strong believer in the power of the free market.  I believe that jobs are best created not by government, but by businesses and entrepreneurs willing to take a risk on a good idea.  I believe that the role of the government is not to disparage wealth, but to expand its reach; not to stifle markets, but to provide the ground rules and level playing field that helps to make those markets more vibrant — and that will allow us to better tap the creative and innovative potential of our people.  For we know that it is the dynamism of our people that has been the source of America’s progress and prosperity.

So I promise you, I did not run for President to bail out banks or intervene in capital markets.  But it is important to note that the very absence of common-sense regulations able to keep up with a fast-paced financial sector is what created the need for that extraordinary intervention — not just with our administration, but the previous administration.  The lack of sensible rules of the road, so often opposed by those who claim to speak for the free market, ironically led to a rescue far more intrusive than anything any of us — Democratic or Republican, progressive or conservative — would have ever proposed or predicted.

At the same time, we have to recognize that what’s needed now goes beyond just the reforms that I’ve mentioned.  For what took place one year ago was not merely a failure of regulation or legislation; it wasn’t just a failure of oversight or foresight.  It was also a failure of responsibility — it was fundamentally a failure of responsibility — that allowed Washington to become a place where problems — including structural problems in our financial system — were ignored rather than solved.  It was a failure of responsibility that led homebuyers and derivative traders alike to take reckless risks that they couldn’t afford to take. It was a collective failure of responsibility in Washington, on Wall Street, and across America that led to the near-collapse of our financial system one year ago.

So restoring a willingness to take responsibility — even when it’s hard to do — is at the heart of what we must do.  Here on Wall Street, you have a responsibility.  The reforms I’ve laid out will pass and these changes will become law.  But one of the most important ways to rebuild the system stronger than it was before is to rebuild trust stronger than before — and you don’t have to wait for a new law to do that.  You don’t have to wait to use plain language in your dealings with consumers.  You don’t have to wait for legislation to put the 2009 bonuses of your senior executives up for a shareholder vote.  You don’t have to wait for a law to overhaul your pay system so that folks are rewarded for long-term performance instead of short-term gains.

The fact is, many of the firms that are now returning to prosperity owe a debt to the American people.  They were not the cause of this crisis, and yet American taxpayers, through their government, had to take extraordinary action to stabilize the financial industry.  They shouldered the burden of the bailout and they are still bearing the burden of the fallout — in lost jobs and lost homes and lost opportunities.  It is neither right nor responsible after you’ve recovered with the help of your government to shirk your obligation to the goal of wider recovery, a more stable system, and a more broadly shared prosperity.

So I want to urge you to demonstrate that you take this obligation to heart.  To put greater effort into helping families who need their mortgages modified under my administration’s homeownership plan.  To help small business owners who desperately need loans and who are bearing the brunt of the decline in available credit.  To help communities that would benefit from the financing you could provide, or the community development institutions you could support.  To come up with creative approaches to improve financial education and to bring banking to those who live and work entirely outside of the banking system.  And, of course, to embrace serious financial reform, not resist it.

Just as we are asking the private sector to think about the long term, I recognize that Washington has to do so as well.  When my administration came through the door, we not only faced a financial crisis and costly recession, we also found waiting a trillion dollar deficit.  So yes, we have to take extraordinary action in the wake of an extraordinary economic crisis.  But I am absolutely committed to putting this nation on a sound and secure fiscal footing.  That’s why we’re pushing to restore pay-as-you-go rules in Congress, because I will not go along with the old Washington ways which said it was okay to pass spending bills and tax cuts without a plan to pay for it.  That’s why we’re cutting programs that don’t work or are out of date.  That’s why I’ve insisted that health insurance reform — as important as it is — not add a dime to the deficit, now or in the future.

There are those who would suggest that we must choose between markets unfettered by even the most modest of regulations, and markets weighed down by onerous regulations that suppress the spirit of enterprise and innovation.  If there is one lesson we can learn from last year, it is that this is a false choice.  Common-sense rules of the road don’t hinder the market, they make the market stronger.  Indeed, they are essential to ensuring that our markets function fairly and freely.

One year ago, we saw in stark relief how markets can spin out of control; how a lack of common-sense rules can lead to excess and abuse; how close we can come to the brink.  One year later, it is incumbent upon us to put in place those reforms that will prevent this kind of crisis from ever happening again, reflecting painful but important lessons that we’ve learned, and that will help us move from a period of reckless irresponsibility, a period of crisis, to one of responsibility and prosperity.  That’s what we must do.  And I’m confident that’s what we will do.

Thank you very much, everybody.  (Applause.)

12:29 P.M. EDT


Other hedge fund law articles related to President Obama and increased hedge fund regulation:

Outstanding Congressional Bills increasing financial regulation:

Bart Mallon, Esq. runs hedge fund law blog and has written most all of the articles which appear on this website.  Mr. Mallon’s legal practice is devoted to helping emerging and start up hedge fund managers successfully launch a hedge fund.  If you are a hedge fund manager who is looking to start a hedge fund, please call Mr. Mallon directly at 415-296-8510.

Investment Adviser Registration Filing Tips

How to get an IA application approved quickly

Occasionally we find the opportunity to comment on other blog posts from other legal professions within and outside of the investment management industry.  A legal blogger who I regularly follow is David Feldman from the Reverse Mergers & SPAC Blog.  David is the expert in the reverse mergers field and has authored the authoritative text Reverse Mergers: Taking a Company Public Without an IPO (Bloomberg Press).  In his post yesterday, Speeding a Self-Filing, he discusses some tips that are designed to help self-filers get through the registration process as quickly as possible.  The points are well-received and I would like to take the opportunity to discuss a couple of the points as they relate to the investment adviser registration process with the various state securities commissions.  [Note: unlike other types of regulatory filings with the SEC, a SEC investment advisor registration is fairly quick and relatively straightforward.  Managers should be aware, however, that the SEC is likely to do a quick examination within the first couple of months after a hedge fund manager registers with the SEC.  Usually this is to make sure the advisor is broadly aware of the compliance issues involved with being registered with the SEC.]


Tip 1

Respond quickly to comments: Management is busy, so are the lawyers and accountants. Nevertheless, one part of the process in your control is how fast you get back to the SEC when they have comments. If you care about getting the self-filing done quickly, drop everything and get the response done as soon as possible.

HFLB thoughts: it is the rare case when a state investment advisor registration gets approved without some sort of comment or inquiry from the securities commission.  Depending on the state, the inquiry can be more or less detailed and probing.  In most cases, however, once an inquiry is provided to the applicant, registration is likely to be right around the corner.  Accordingly, once an inquiry is provided to the manager, the manager and the lawyer should work to get a response drafted immediately.

Tip 2

Don’t argue on comments you will probably give in on later: Often a company or accountant will say, well, we think they will very likely not give us any room on our response, but let’s try and see what happens. If you care about the speed of the process, it is usually not worth challenging comments if your advisers believe there is virtually no chance of success.

HFLB thoughts: we would also like to add that if the regulators are asking for something that does not materially affect the investment program or the manner in which the management company will operate, the manager might be better off acquiescing instead of fighting.  I have had groups fight with regulators on principles only to later abandon the fight for practicality.  There is definitely an element of picking your battles wisely.

Tip 3

Always be respectful: The SEC is an important and powerful government agency. Almost everyone I have worked with there are highly intelligent and well-meaning folks. But their focus sometimes jibes with that of companies they are seeking to regulate for the protection of investors. Make sure you are always respectful and responsive to the SEC. Not only do they deserve it, but belligerence is just as likely to lead to more ire from them than positive results.

HFLB thoughts: this is an extremely important point.  Regulators are charged with a tough and important job and it does not help anyone to be anything less than absolutely respectful.

Many of the above comments apply equally as well for those groups who are registering with other regulatory bodies such as the CFTC (as a CPO or a CTA) and who need to go through the NFA disclosure document review process.


Please contact us if you have any questions about investment advisor registration or if you would like information on starting a hedge fund. Other related hedge fund law articles include:

Bart Mallon, Esq. runs hedge fund law blog and has written most all of the articles which appear on this website.  Mr. Mallon’s legal practice, Cole-Frieman & Mallon LLP, is devoted to helping emerging and start up hedge fund managers successfully launch a hedge fund.  If you are a hedge fund manager who is looking to start a hedge fund, or if you have questions about investment adviser registration with the SEC or state securities commission, please call Mr. Mallon directly at 415-296-8510.

Private Fund Investment Advisers Registration Act of 2009

Bart Mallon, Esq.

****UPDATE 10/27/2009****

The House Financial Services Committee voted on October 27, 2009 to pass the Private Fund Investment Advisers Registration Act of 2009 as H.R. 3818 (full text of bill as passed – please note that it is different from the earlier version of the bill reprinted below).  The bill as passed by the committee required private equity fund managers to register but specifically excludes managers of venture capital funds from the registration requirements.  The House Committee released a press release discussing the bipartisan vote.


Text of Private Fund Investment Advisers Registration Act of 2009

Today the Obama Administration released its proposed legislation which would require hedge fund managers to register with the SEC (as well as private equity fund and venture capital fund managers). The full text of the Private Fund Investment Advisers Registration Act of 2009 has been copied below.




This Act may be cited as the “Private Fund Investment Advisers Registration Act of 2009”.


Section 202(a) of the Investment Advisers Act of 1940 (15 U.S.C. 80b-2(a)) is amended by adding at the end the following:

“(29) The term ‘private fund’ means an investment fund that—

“(A) would be an investment company (as defined in section 3 of the Investment Company Act of 1940 (15 U.S.C. 80a-3)), but for section 3(c)(1) or 3(c)(7) of the Investment Company Act of 1940 (15 U.S.C. 80a-3(c)(1) or 80a-3(c)(7)); and

“(B) either—

“(i) is organized or otherwise created under the laws of the United States or of a State; or

“(ii) has 10 percent or more of its outstanding securities owned by U.S. persons.

“(30) The term ‘foreign private adviser’ means any investment adviser who—

“(A) has no place of business in the United States;

“(B) during the preceding 12 months has had—

“(i) fewer than 15 clients in the United States; and

“(ii) assets under management attributable to clients in the United States of less than $25,000,000, or such higher amount as the Commission may, by rule, deem appropriate in accordance with the purposes of this title; and

“(C) neither holds itself out generally to the public in the United States as an investment adviser, nor acts as an investment adviser to any investment company registered under the Investment Company Act of 1940, or a company which has elected to be a business development company pursuant to section 54 of the Investment Company Act of 1940 (15 U.S.C. 80a-53), and has not withdrawn its election.”.


Section 203(b) of the Investment Advisers Act of 1940 (15 U.S.C. 80b-3(b)) is amended—

(a) in paragraph (1), by inserting “, except an investment adviser who acts as an investment adviser to any private fund,” after “investment adviser” the first time it appears;

(b) by amending paragraph (3) to read as follows:

“(3) any investment adviser that is a foreign private adviser;”; and

(c) in paragraph (6)—

(1) in subparagraph (A), by striking “or”;

(2) in subparagraph (B), by striking the period at the end and adding “; or”; and

(3) by adding at the end the following new subparagraph:

“(C) a private fund.”


Section 204 of the Investment Advisers Act of 1940 (15 U.S.C. 80b-4) is amended—

(a) by redesignating subsections (b) and (c) as subsections (c) and (d); and

(b) by inserting after subsection (a) the following new subsection (b):


“(1) IN GENERAL.—The Commission is authorized to require any investment adviser registered under this Act to maintain such records of and submit to the Commission such reports regarding private funds advised by the investment adviser as are necessary or appropriate in the public interest and for the assessment of systemic risk by the Board of Governors of the Federal Reserve System and the Financial Services Oversight Council, and to provide or make available to the Board of Governors of the Federal Reserve System and the Financial Services Oversight Council those reports or records or the information contained therein. The records and reports of any private fund would be an investment company, to which any such investment adviser provides investment advice, maintained or filed by an investment adviser registered under this Act shall be deemed to be the records and reports of the investment adviser.

“(2) REQUIRED INFORMATION.—The records and reports required to be filed with the Commission under this subsection shall include but shall not be limited to the following information for each private fund advised by the investment adviser:

“(A) amount of assets under management, use of leverage (including off-balance sheet leverage), counterparty credit risk exposures, trading and

investment positions, and trading practices; and

“(B) such other information as the Commission, in consultation with the Board of Governors of the Federal Reserve System, determines necessary or appropriate in the public interest and for the protection of investors or for the assessment of systemic risk.

“(3) MAINTENANCE OF RECORDS.—An investment adviser registered under this Act is required to maintain and keep such records of private funds advised by the investment adviser for such period or periods as the Commission, by rules and regulations, may prescribe as necessary or appropriate in the public interest and for the protection of investors or for the assessment of systemic risk.


“(A) PERIODIC AND SPECIAL EXAMINATIONS.—All records of a private fund maintained by an investment adviser registered under this Act shall be subject at any time and from time to time to such periodic, special, and other examinations by the Commission, or any member or representative thereof, as the Commission may prescribe.

“(B) AVAILABILITY OF RECORDS.—An investment adviser registered under this Act shall make available to the Commission or its representatives any copies or extracts from such records as may be prepared without undue effort, expense or delay as the Commission or its representatives may reasonably request.

“(5) INFORMATION SHARING.— The Commission shall make available to the Board of Governors of the Federal Reserve System and the Financial Services Oversight Council copies of all reports, documents, records and information filed with or provided

to the Commission by an investment adviser under section 204(b) as the Board or the Council may consider necessary for the purpose of assessing the systemic risk of a private fund or assessing whether a private fund should be designated a Tier 1 financial holding company. All such reports, documents, records and information obtained by the Board or the Council from the Commission under this subsection shall be kept confidential.

“(6) DISCLOSURES BY PRIVATE FUND.—An investment adviser registered under this Act shall provide such reports, records and other documents to investors, prospective investors, counterparties, and creditors, of any private fund advised by the investment adviser as the Commission, by rules and regulations, may prescribe as necessary or appropriate in the public interest and for the protection of investors or for the assessment of systemic risk.

“(7) CONFIDENTIALITY OF REPORTS.—Notwithstanding any other provision of law, the Commission shall not be compelled to disclose any supervisory report or information contained therein required to be filed with the Commission under subsection (b). Nothing in this subsection shall authorize the Commission to withhold information from Congress or prevent the Commission from complying with a request for information from any other Federal department or agency or any self-regulatory organization requesting the report or information for purposes within the scope of its jurisdiction, or complying with an order of a court of the United States in an action brought by the United States or the Commission. For purposes of section 552 of title 5, United States Code, this subsection shall be considered a statute described in subsection (b)(3)(B) of such section 552.”.


Section 210 of the Investment Advisers Act of 1940 (15 U.S.C. 80b-10) is amended by striking subsection (c).


Section 211 of the Investment Advisers Act of 1940 (15 U.S.C. 80b-11) is amended—

(1) in subsection (a)—

(A) by striking the second sentence; and

(B) by striking the period at the end of the first sentence and inserting the following:

“, including rules and regulations defining technical, trade, and other terms used in this title. For the purposes of its rules and regulations, the Commission may—

“(1) classify persons and matters within its jurisdiction and prescribe different requirements for different classes of persons or matters; and

“(2) ascribe different meanings to terms (including the term ‘client’) used in different sections of this title as the Commission determines necessary to effect the purposes of this title.”; and

(2) by adding at the end the following new subsection:

“(e) The Commission and the Commodity Futures Trading Commission shall, after consultation with the Board of Governors of the Federal Reserve System, within 6 months after the date of enactment of the Private Fund Investment Advisers Registration Act of 2009, jointly promulgate rules to establish the form and content of the reports required to be filed with the Commission under subsection 204(b) and with the Commodity Futures Trading Commission by investment advisers that are registered both under the Investment Advisers Act of 1940 (15 U.S.C. 80b et seq.) and the Commodity Exchange Act (7 U.S.C. 1a et seq.).”.


Bart Mallon, Esq. runs hedge fund law blog and has written most all of the articles which appear on this website.  Mr. Mallon’s legal practice is devoted to helping emerging and start up hedge fund managers successfully launch a hedge fund.  Mallon P.C. helps hedge fund managers to register as investment advisors with the SEC or the state securities divisions.  If you are a hedge fund manager who is looking to start a hedge fund or register as an investment advisor, please contact us or call Mr. Mallon directly at 415-296-8510.  Other related hedge fund law articles include:

Obama Moves Forward with Hedge Fund Registration Legislation

Bart Mallon, Esq.

Treasury Announces New “Private Fund Investment Advisers Registration Act of 2009”

After much discussion in the press over the last 8 to 10 months abut the possibility for hedge fund registration, the Treasury today announced the Obama Administration’s bill which requires managers to “private funds” to register with the SEC.  This registration requirement would apply to managers of all funds relying on the Section 3(c)(1) or Section 3(c)(7) which includes managers to private equity and venture capital funds.  Additionally, all registered managers would need to provide the SEC with certain reports on the funds which they manage.

The Treasury release is below and can be found here.  We will post the text of the new act shortly.  [Update: we have just published the text of the Private Fund Investment Advisers Registration Act of 2009.]


Fact Sheet: Administration’s Regulatory Reform Agenda Moves Forward: Legislation for the Registration of Hedge Funds Delivered to Capitol Hill

Continuing its push to establish new rules of the road and make the financial system more fair across the board, the Administration today delivered proposed legislation to Capitol Hill to require all advisers to hedge funds and other private pools of capital, including private equity and venture capital funds, to register with the Securities and Exchange Commission (SEC). In recent years, the United States has seen explosive growth in a variety of privately-owned investment funds, including hedge funds, private equity funds, and venture capital funds. At various points in the financial crisis, de-leveraging by such funds contributed to the strain on financial markets.  Because these funds were not required to register with regulators, the government lacked the reliable, comprehensive data necessary to monitor funds’ activity and assess potential risks in the market.  The Administration’s legislation would help protect investors from fraud and abuse, provide increased transparency, and provide the information necessary to assess whether risks in the aggregate or risks in any particular fund pose a threat to our overall financial stability.

Protect Investors From Fraud And Abuse

Require Advisers To Private Investment Funds to Register With The SEC.  Although some advisers to hedge funds and other private investment funds are required to register with the Commodity Futures Trading Commission (CFTC), and some register voluntarily with the SEC, current law generally does not require private fund advisers to register with any federal financial regulator. The Administration’s legislation would, for the first time, require that all investment advisers with more than $30 million of assets under management to register with the SEC.  Once registered with the SEC, investment advisers to private funds will be subject to important requirements such as:

  • Substantial regulatory reporting requirements with respect to the assets, leverage, and off-balance sheet exposure of their advised private funds
  • Disclosure requirements to investors, creditors, and counterparties of their advised private funds
  • Strong conflict-of-interest and anti-fraud prohibitions
  • Robust SEC examination and enforcement authority and recordkeeping requirements
  • Requirements to establish a comprehensive compliance program

Require Increased Disclosure Requirements. The Administration’s legislation would require that all investment funds advised by an SEC-registered investment adviser be subject to recordkeeping requirements; requirements with respect to disclosures to investors, creditors, and counterparties; and regulatory reporting requirements.

Protect Financial System From Systemic Risk

Monitor Hedge Funds For Potential Systemic Risk. Under the Administration’s legislation, the regulatory requirements mentioned above would include confidential reporting of amount of assets under management, borrowings, off-balance sheet exposures, counterparty credit risk exposures, trading and investment positions, and other important information relevant to determining potential systemic risk and potential threats to our overall financial stability. The legislation would require the SEC to conduct regular examinations of such funds to monitor compliance with these requirements and assess potential risk. In addition, the SEC would share the disclosure reports received from funds with the Federal Reserve and the Financial Services Oversight Council. This information would help determine whether systemic risk is building up among hedge funds and other private pools of capital, and could be used if any of the funds or fund families are so large, highly leveraged, and interconnected that they pose a threat to our overall financial stability and should therefore be supervised and regulated as Tier 1 Financial Holding Companies.


Bart Mallon, Esq. runs hedge fund law blog and has written most all of the articles which appear on this website.  Mr. Mallon’s legal practice is devoted to helping emerging and start up hedge fund managers successfully launch a hedge fund.  Mallon P.C. helps hedge fund managers to register as investment advisors with the SEC or the state securities divisions.  If you are a hedge fund manager who is looking to start a hedge fund or register as an investment advisor, please contact us or call Mr. Mallon directly at 415-296-8510.  Other related hedge fund law articles include:

Obama Administration Proposes New Regulatory Agency

Assistant Secretary Michael Barr Testifies Before House Committee Regarding President’s Proposal to Establish New Consumer Financial Protection Agency

On July 8th, 2009, Assistant Secretary Michael Barr delivered a statement before the House Committee on Energy and Commerce regarding the Administration’s recent proposal to establish a new financial regulatory agency designated with the sole task of protecting consumers across the financial services industry.   Per the proposal, the new Consumer Financial Protection Agency will set consistently high standards for financial service providers to protect consumers from abuse.  In his statement, Barr points out that the current system for consumer protection is inherently flawed due to various inadequacies, including the lack of unified leadership, federal supervision, and an enforceable system for accountability. He also cites that the root cause of these various setbacks is a ‘fragmented regulation’, in which one agency was responsible for enacting regulations while another agency was responsible for enforcement.  With a new singular agency in the marketplace dedicated to protecting consumers against regulatory arbitrage, the financial industry will once again be restored with the confidence and protections necessary to hopefully make regulatory arbitrate a thing of the past.

Consumer Financial Protection Agency Act of 2009, a part of Obama’s new financial regulation plan, details the Administration’s initiative to create the new dedicated agency.  President Obama’s statement with regard to this new agency can be found here.

The full text of the related press release on this matter is reprinted below.


July 8, 2009

Assistant Secretary for Financial Institutions Michael Barr before the House Committee on Energy and Commerce Subcommittee on Commerce, Trade, and Consumer Protection

Opening Statement – As Prepared for Delivery

Thank you, Chairman Rush and Ranking Member Radanovich, for providing me with this opportunity to testify about the Administration’s proposal to establish a new, strong financial regulatory agency charged with just one job: looking out for consumers across the financial services landscape.  Last week, the Administration sent legislative language to Congress to create the new agency, and in the coming weeks, we will continue to transmit legislation to implement other core proposals to strengthen regulation of financial institutions and markets and lay the foundation for a safer, more stable financial system.

As Secretary Geithner has said, protecting consumers is important in its own right and also central to safeguarding the system as a whole.  We must restore honesty and integrity to our financial system, in order to restore trust and confidence.  A key step to doing so is to establish clear federal accountability for protecting consumers and the authority necessary to carry out the job.

That is why the President is proposing the Consumer Financial Protection Agency.

We will have one agency for one marketplace with one mission – to protect consumers.  It will have the authority and resources it needs to set consistently high standards and a level playing field across the financial services sector–for banks and non-bank financial services providers alike.  Its market-wide jurisdiction will put an end to regulatory arbitrage and unregulated corners that inevitably weaken standards across the board.  Structures and mechanisms in our legislation will ensure the agency remains accountable for its mission, yet independent.  The Agency could choose from a wide range of tools to promote transparency, simplicity, and fairness.  The breadth and diversity of these tools will enable it to adopt the most effective and proportionate, and least costly, approach to any problem.  It will have the tools and resources to maintain expertise, and the incentives to act in a balanced manner that protects consumers from abuse while ensuring their access to innovative, responsible financial services.  At the same time, the Federal Trade Commission would retain key powers and gain new ones, including streamlined rulemaking procedures and heightened penalties for violations.

The Current System for Consumer Financial Protection Regulation is Fundamentally Flawed

A dedicated consumer protection agency for financial services is the only effective response to inherent weaknesses in our existing oversight regime.  The financial crisis revealed the alarming failure of this regime to protect responsible consumers – and keep the playing field level for responsible providers.  The federal government has failed in its most basic regulatory responsibility: to protect consumers.  And no provider should be forced to choose between keeping market share and treating consumers fairly.  The states do their best with limited resources but they look to the federal government for leadership, and there is no federal agency with the structure and authority to lead.

Instead of leadership and accountability, there is a fragmented system of regulation designed for failure.  Bank and non-bank financial service providers often compete vigorously in the same consumer markets but are subject to two different and uncoordinated federal regimes – one based on examinations and supervision, the other based on after-the-fact investigations and enforcement actions.  The lack of federal supervision of non-bank providers is an open invitation to the less responsible actors that seek darker corners to ply their dubious practices.  These actors are willing to gamble that the FTC and state agencies lack the resources to detect and investigate them.  This puts enormous pressure on banks, thrifts, and credit unions to lower their standards to compete – and on their regulators to let them.  Fragmentation of the supervision of banks and thrifts only makes this problem worse: a banking institution can choose the least restrictive among several different supervisory agencies.  Despite best intentions, “regulatory arbitrage” inevitably weakens protections for consumers and feeds bad practices.

This is precisely what happened in the mortgage market.  Independent mortgage companies and brokers grew apace with little oversight.  They peddled subprime and exotic mortgages – such as “option ARMs” with exploding payments and rising loan balances – in misleading ways to consumers least able to handle their complex terms and hidden, costly features.  The FTC and the states took enforcement actions, but their resources were no match for rapid market growth, and they could not set rules of the road for the whole industry or supervise institutions to prevent bad practices from spreading.  To compete over time, banks and thrifts and their affiliates came to offer the same risky products as their less regulated competitors and relaxed their standards for underwriting and sales.  Lenders of all types paid their mortgage brokers and loan officers more to bring in riskier and higher-priced loans, with predictable results.  Bank regulators were slow to recognize these problems, and even slower to act.  The consequences for homeowners were devastating, and our economy is still paying the price.

Our system allowed this to take place even entirely within the highly-regulated, closely-supervised world of banks and thrifts.  Take credit cards.  Some banks found they could boost fee and interest income with complex and opaque terms and features that most consumers would not notice or understand.  These tricks enabled banks to advertise seductively low annual percentage rates and grab market share.  Other banks found they could not compete if they offered fair credit cards with more transparent pricing.  So consumers got retroactive rate hikes, rate hikes without notice, and low-rate balance transfer offers that trapped them in high-rate purchase balances.  A major culprit, once again, was fragmented regulation: one agency held the pen on regulations, another supervised most of the major card issuers.  Each looked to the other to act, and neither acted until public outrage reached a crescendo.

The list goes on.  A wide range of credit products are offered–from payday loans to pawn shops, to auto loans and car title loans, many from large national chains–with little supervision or enforcement.  Closely regulated credit unions and community banks with straightforward credit products struggle to compete with  less scrupulous providers who appear to offer a good deal and then pull a switch on the consumer.   For instance, overdraft policies are a form of credit but are not disclosed or regulated as such.

The problem with our system is not just the gaps and overlaps between regulators.  Our federal agencies do not have missions, structures, and authorities suited to effective consumer protection in financial markets.  The FTC has a broad mission to protect consumers in all markets, of which the financial services market is just one; and it has no jurisdiction over banks.   The agency has brought important cases against some of the worst financial abusers, but these cases often take a long time and the damage is already done.  The agency does not have the supervisory and examination authority or expertise needed to detect and prevent problems before they spread throughout the market.

Bank regulators have supervisory powers over banks, but their primary mission is to ensure banks are safe and sound, not to protect consumers.  Consumer supervision does not fit comfortably within these agencies, and it will never share the front seat with safety and soundness.  Too often, consumer compliance supervision focused on “checking boxes” – is the annual percentage rate on this loan calculated as prescribed?  Is it displayed with a large enough type size?  That often meant missing the forest for the trees.

It was thought that supervising the banks for their effective management of “reputation risk” and “litigation risk” – aspects of a safe and sound institution — would ensure the banks treated their customers fairly.  It didn’t.  It did not prevent our major banks and thrifts from retroactively raising rates on credit cards as a matter of policy, or from selling exploding mortgages to unwitting consumers as a business expansion plan.  Managing a bank’s reputation and litigation risk does not and cannot protect consumers because this approach judges a bank’s conduct toward consumers by its effect on the bank, not its effect on consumers.

We Need One Agency for One Marketplace with One Mission – to Protect Consumers – and the Authority to Achieve It

Tinkering with the consumer protection mandates or authorities of our existing agencies cannot solve the fundamental problem that they are organizationally ill-designed to protect consumers, and too fragmented to maintain high and consistent standards across the consumer financial marketplace.  There is only one solution that can work.  We need one agency for one marketplace with one mission – to protect consumers of financial products and services – and the authority to achieve that mission.  A new agency with a focused mission, comprehensive jurisdiction, and broad authorities is also the only way to ensure consumers and providers high and consistent standards and a level playing field across the whole marketplace without regard to the form of a product – or the type of its provider.

That is the agency we are proposing to create.  The CFPA will have the sole mission of protecting consumers; it will be the agency that sees the world through their eyes.  It will write regulations, supervise institutions and providers for compliance, and lead enforcement efforts – for the whole marketplace.  The implications of our proposal for consumer protection and fair competition are enormous.  It will bring higher and more consistent standards; stronger, faster responses to problems; the end of regulatory arbitrage; a more level playing field for all providers; and more efficient regulation.

Let me start with rule writing.  The CFPA will be able to write rules for all consumer financial services and products and anyone who provides these products.  It will assume existing statutory authorities – such as the Truth in Lending Act and Equal Credit Opportunity Act.  New authorities we propose – to require transparent disclosure, promote simple choices, and ensure fair terms and conditions and fair dealing – will enable the agency to fill gaps as markets change and to provide strong and consistent regulation across all types of consumer financial service providers.

For example, our proposal gives the CFPA the power to strengthen mortgage regulation by requiring lenders and brokers to clearly disclose major product risks, and offer simple, transparent products if they decide to offer exotic, complex products.  The CFPA will also be able to impose duties on salespeople and mortgage brokers to offer appropriate loans and meet a duty of best execution, and prevent lenders from paying “yield spread premiums” that pay brokers more if they deliver loans with higher rates than consumers qualify for.  Lenders and consumers would finally have an integrated mortgage disclosure: the CFPA will continue the work of the Federal Reserve and the Department of Housing and Urban Development to create and maintain a single, federal mortgage disclosure.

Comprehensive rule writing authority would improve other markets, too.   For example, the CFPA could adopt consistent regulations for short-term loans – establishing disclosure requirements and banning unfair practices – whether these loans come in the form of bank overdraft protection plans or payday loans or  car title loans from non-bank providers.  The agency also could adopt standards for licensing and monitoring check cashers and pawn brokers.

Combining these robust rule writing authorities with supervision and enforcement authorities in one agency will ensure faster and more effective rules.  For example, the CFPA will both implement the new Credit CARD Act of 2009 – to ban retroactive rate hikes and rate hikes without notice – and will supervise the credit card banks for compliance.  So the agency will have a feedback loop from the examiners of the banks to the staff who write the regulations, allowing staff to determine quickly how well the regulations are working in practice and whether they need to be tightened or adjusted.  That feedback loop is broken today because rule writing and supervision are divided between two agencies.  Consolidated supervisory authority would also allow faster action on mortgages to prevent irresponsible practices that undermine responsible lenders.  It took the federal banking agencies two years to reach final consensus on supervisory guidance on option ARMs and subprime mortgages after evidence of declining underwriting standards emerged publicly.  A single agency could act within months and save many more consumers and communities from significant harm.

Our proposal for comprehensive jurisdiction will also make regulatory arbitrage a thing of the past.  Providers will not have a choice of regulators.  So, by definition, they will not be able to choose a less restrictive regulator.  The CFPA will not have to fear losing “market share” because our legislation gives it authority over the whole market.  Ending arbitrage will prevent the vicious cycles that weaken standards across the market.

Consolidating consumer protection in an agency with comprehensive jurisdiction will also protect consumers no matter with whom they do business, and level the playing field for all institutions and providers.  Consumers do not care what legal form their service provider takes; nor should they.  A short-term loan can be made by a bank, a bank affiliate, a finance company, or a payday lender.  The CFPA could apply to non-bank providers the tools of supervision that regulators now apply to banks – including setting compliance standards, conducting compliance examinations, reviewing files, obtaining data, issuing supervisory guidance and entering into consent decrees or formal orders.  The CFPA would have the ability to send examiners into the large, fast-growing independent mortgage companies that caused most of the damage during the mortgage boom to review loan files and interview salespeople.  With these tools, the Agency would be able to identify problems before they spread, stop them before they cause serious injury, and relieve pressures on responsible providers to lower their standards.

The CFPA is not a new layer of regulation; it will consolidate existing regulators and authorities.  This will bring efficiencies for industry.  It will have a clear address for concerns about regulatory burden, and it can expect speedier responses to legitimate claims of unwarranted burdens.  Moreover, responsible industry actors will worry less about unfair competition from irresponsible actors, since all providers will be under this agency’s jurisdiction.

Of course, even with a strong supervisory and enforcement staff, no agency can oversee tens of thousands of financial service providers on its own.  The FTC and the states will continue to play critical roles.  The FTC will retain authority to investigate and prosecute financial-related frauds under its FTC Act authority to prevent unfair or deceptive practices.  The states will continue to license and bond non-bank service providers, with authority for the CFPA to set strong new federal standards and directly and forcefully to act, by sending in supervisors and examiners when risks are warranted.  The CFPA will be able to coordinate closely with the FTC and the states to share information and shore up weaknesses.

The CFPA Will be Held Accountable While Remaining Independent

The public deserves accountability for consumer protection, and creating the CFPA will, finally, give them that accountability.  Consumers and their elected representatives will have a place to bring their consumer protection concerns, and one agency to hold accountable for results.  Clear accountability will, therefore, produce better results.

Our legislation contains specific measures to help ensure better regulation and prevent agency inertia or backsliding.  The CFPA will maintain a unit to analyze consumer complaints across the full range of providers – banks and non-banks – and markets.  Its analysis will be published annually.  The agency also will maintain a research unit to track changes in markets, products, and consumer behavior and assess risks to consumers – and their understanding of these risks.  The agency will give particular consideration to monitoring fast-growing providers and products – such as independent mortgage companies and subprime loans during the housing boom – where risks are often higher.  The CFPA will publish significant findings of these monitoring activities at least once each year, and report annually to Congress on its regulatory, enforcement, and supervisory activities.

Accountability must be balanced with independence.  The agency will have a stable funding stream in the form of  appropriations and fee assessments akin to those regulators impose today.  Stable funding is a necessary, but not sufficient, ingredient for true independence.  Sustained independence also depends on expertise and respect.  The agency will be able to hire a top notch and diversified staff.  Our legislation would provide the agency’s attorneys, economists, finance experts, examiners, and other professionals the same salaries on average as professionals of the banking agencies.  The agency would absorb the banking agencies’ teams of consumer compliance examiners, and hire and train new examiners for non-bank providers.

The CFPA Will Be  Effective Because it will be Expert, and its Actions Will be Balanced and Proportionate

We are proposing the CFPA be given broad authorities.  Our legislation is designed to ensure the agency uses these authorities effectively and with expertise, balance, and proportion – qualities that will ensure the agency remains effective and independent.

Deep and sophisticated understanding.  Our legislation assures the CFPA will have the deep understanding of consumers, providers, and products it will need to write rules that are effective, balanced, and proportional.   As mentioned above, a research unit, consumer surveys and testing, complaint tracking and compliance examiners will help ensure that the CFPA is up-to-date with developments in the market.  As they do today, examiners for the largest and most complex institutions, whether banks or non-banks, will reside on-site so they fully understand products and operations.  These mechanisms will provide the agency critical information to craft effective, tailored regulations that do not impose unnecessary costs, and to determine when regulations should be expanded, modified, or eliminated.

Balanced regulations.  When it adopts and reviews regulations, the agency will be required to balance a range of competing objectives.  Its four-fold mission includes (1) protecting consumers from abusive or unfair practices; (2) ensuring that they have the information they need to make responsible choices; (3) ensuring markets are efficient and have ample room for innovation, and (4) promoting access to financial services.  The CFPA will have to balance these potentially competing goals.  Our legislation also explicitly requires the CFPA to consider the costs, not just the benefits, of regulations to consumers and financial institutions – including any potential reduction in consumers’ access to financial services.  Moreover, the agency will be able to adopt appropriate exemptions from its rules for providers or products where necessary to fulfill the four objectives.  Once it adopts a major regulation, the agency will have to review it within five years to make sure it remains consistent with these objectives

Flexible approaches and tailored solutions.  Comprehensive authority over the whole market will give the agency a range of options for setting standards so it can choose the most effective, least-cost option.  When flexibility is at a premium, the agency can issue supervisory guidance and use examination reports and other techniques to foster change.  Today, supervisory guidance usually must be agreed to by four or more federal agencies and fifty states, which causes considerable delays and dilutes effectiveness.  One agency for one market will make guidance a much more effective tool than it is today.  When a stricter approach is appropriate, the agency can adopt regulations and impose penalties for violations.

Moreover, diverse rule writing authorities will ensure the agency can tailor its regulations to the underlying problem with the least cost to consumers and institutions.  The agency will have ample authority to harness the benefits of market discipline by improving the quality of, and access to, information in the marketplace.  For example, it will have authority for principles-based, non-technical standards to ensure marketing materials and sales pitches are reasonable and include clear disclosure of product risks in balance with advertised benefits.  We have included authority for the agency to permit providers to pilot new disclosure approaches.  The agency will also be able to adopt new, more concrete disclosures that highlight for consumers the consequences of their decisions – akin to the minimum payment warning on credit card periodic statements under the Credit CARD Act of 2009.  Consumers, themselves, will be able to access their financial information in a usable, electronic format so they can conduct their own assessments of decisions they have made or are planning to make.  Increasing the quality and accessibility of product information will make it easier for consumers and providers alike to understand the marketplace and make better choices.

The agency will also be able to encourage providers to offer simple products to help comparison shopping.  For example, providers that offer exotic, complex, and riskier products would need to offer at least one standard, simple, less risky product.  In the mortgage market, a lender or broker that peddles mortgages with potentially exploding monthly payments, hidden fees and prepayment penalties, and growing loan balances – such as the “pay option ARMs” of recent years – might also be required to offer consumers 30-year, fixed-rate mortgages or ARMs with straightforward terms.  The point is to make it easier for consumers to choose simpler products, which should limit the need for costlier restrictions on terms and practices.

The agency will also have the ability to align incentives, which can sometimes be more effective than outlawing particular terms or practices and chasing down the inevitable circumventions.  It will have authority to impose duties on frontline salespeople and middle men and regulate the form, manner, or timing – but not amount – of their compensation as needed to promote fair dealing.  If they give financial advice and consumers reasonably rely on it, the agency will be able to ensure their advice meets a minimum standard of care.  The agency will also be able to ensure salespeople and middle men are not paid more to take advantage of consumers’ trust or inexperience.  For example, the agency might decide to prohibit mortgage lenders from paying salespeople or brokers higher bonuses for delivering loans with higher interest rates than borrowers qualify for, with hidden costly fees, since this creates a perverse incentive to mislead consumers into taking out costlier loans.

With a broad range of supervisory and regulatory tools, the agency will be able to choose the most effective, least costly solution for each problem.  Let me give you an example of how this might work.  In response to the strong protections of the Credit CARD Act of 2009, credit card issuers will substantially change their terms and practices.  New terms or practices may raise new questions of fairness.  If that happens, the CFPA will be able to proceed deliberately and in stages.  For example, it could begin by asking card issuers to produce evidence that consumers understand the new terms or practices and can avoid the risks they pose.  If this evidence seems inadequate, the agency could conduct its own testing with consumers.  If this testing showed widespread lack of consumer understanding, the agency could consider a range of options, from improving disclosure to providing stronger incentives to offer simpler products to further restricting unfair terms and practices.

Respect for safety and soundness.  When it uses these authorities, the CFPA will respect the safety-and-soundness imperatives of bank regulation.  When conflicts do arise, structures for compromise will facilitate resolution. A safety and soundness regulator will have one of five board seats, and the agency must consult with safety and soundness regulators before adopting rules.  In addition, the CFPA can work with the banking agencies to ensure bank consumer compliance examiners are trained to understand safety and soundness, as they are today.

In short, the comprehensive authority we propose will not increase regulatory burden or lead to unreasonable regulations.  It will do the opposite.  It will ensure the agency has a deep understanding of products and providers.  And it will enable the agency to choose from among a wide range of tools and authorities to find the most effective, least-cost solution.  This will save consumers – and financial service providers – significant costs over the long term.

Our Legislation Will Respect and Strengthen the Core Functions of the Federal Trade Commission

Our legislation does not affect the jurisdiction of the FTC over the vast array of non-financial markets and actually strengthens its ability to police those markets.  To increase the FTC’s ability to protect consumers, we propose that the FTC be able to (1) adopt rules to prohibit unfair or deceptive acts or practices with standard notice-and-comment rulemaking; (2) obtain civil penalties when companies use unfair or deceptive practices; and (3) pursue those who substantially aid and abet providers that commit unfair or deceptive practices.  The Administration also supports increased resources in the 2010 President’s Budget for the FTC so that consumers can be better protected across all markets.

As for financial markets, the FTC will continue to have authority under the FTC Act to pursue financial fraud without delay, including foreclosure rescue and loan modification scams.  The  FTC would simply be required to consult and coordinate with – but not refer these cases to – the CFPA.  The CFPA would also have authority under the proposed legislation to pursue fraud and deceptive practices by financial service providers.  The consultation requirement ensures there will be coordination, much like the coordination that occurs informally between the states and the FTC today in pursuing fraud.  The FTC will also retain authority for writing rules under the Telemarketing Sales Act and concurrent responsibility for enforcing them over financial products and services.

The CFPA will have substantial authority over mortgages under other statutes, so it will assume the rulemaking authority recently granted to the FTC over mortgage loans.  This assures consumers and providers a consistent and consolidated approach to regulating mortgages throughout the whole life of the loan, from sale and origination to payoff, modification, or foreclosure.

With respect to rules or statutes other than the FTC Act, the FTC will have “backstop” authority to enforce the same consumer credit statutes that it can enforce now.  Under that authority, if the FTC – or a bank regulator – becomes aware of a possible law violation of those statutes, it may send a written recommendation that the CFPA take action, stating its concerns, and proceed itself on the matter after 120 days if the CFPA does not take action.  The Administration is proposing to apply the same referral requirement to the bank regulators.  This requirement will help ensure a consistent federal approach to interpreting and enforcing consumer protection statutes such as the Truth in Lending Act, while leaving the FTC and the banking agencies the ability to act if the CFPA does not.  The approach is flexible enough to permit the agencies to agree to practical arrangements for referrals and appropriate use of the FTC’s backstop authority.

The FTC would retain primary authority in the area of data security for nonbank entities.  It would continue its current role of enforcing, as to nonbank financial service providers, Section 5 of the FTC Act as it applies to  data security practices and its Safeguards Rule, which implements Section 501(b) of the Gramm-Leach- Bliley Act. [1][1]  Consistent with the CFPA’s exclusive authority over consumer disclosure in other areas, however, the CFPA would have primary authority under the “front end” privacy provisions of GLBA (e.g. privacy notice and related provisions) for all financial institutions (banks and nonbanks), and as well as its own authority under the proposed legislation that parallels Section 5 of the FTC Act.


Our proposal will ensure the financial regulator community includes one agency with the single mission of protecting consumers.  It is time to put consumer protection responsibility in an agency with a focused mission and comprehensive jurisdiction over all financial services providers, banks and non-banks.  It is time for a level playing field for financial services competition based on strong rules, not based on exploiting consumer confusion.  It is time for an agency that consumers – and their elected representatives – can hold fully accountable.  And it is long past time for a stronger FTC.  The Administration’s legislation fulfills these needs.  Thank you for this opportunity to discuss our proposal, and I will be happy to answer any questions.

[1] Because of its relationship to data security, the FTC would also retain its rulemaking and enforcement authority for the Red Flags Rule under Section 615(e) and the Disposal Rule under Section 628 of the FCRA.   The remainder of rulemaking and enforcement authority under the FCRA would transfer to the CFPA.


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Hedge Funds with $25MM of AUM to Register Under Commissioner Aguilar’s Plan

SEC Commissioner Aguilar Proposes Registration For Funds with as little as $25MM of AUM

Just today I had an opportunity to review the transcript of a speech by SEC Commissioner Aguilar in which he advocates that funds with as little as $25MM of AUM should register with the SEC.  Such a low threshold for registration is troubling in a number of ways.  Most importantly is the impact registration would have on the SEC immediately and in the future.  As we have seen most vividly over the past year, the SEC is overextended and underfunded.  The SEC’s ability to adequately deal with the 9,000 to 12,000 hedge funds which would come under its jurisdicition is suspect.  Registration aside, how will an agency which was not able to sniff out a Bernie Madoff be able to oversee such a large industry without making it cost prohibitive for funds to operate?  The money required to oversee these funds is likely to be substantial and will probably not be coming from Congress which means the cost of such a regulatory and oversight system will likely fall onto the managers themselves and then of course to the investors.

As we talk about regulation of the hedge fund industry, there is also the question of regulatory resources. Any future registration of hedge fund advisers and/or hedge funds will require that the SEC receive increased resources to provide effective oversight. We will need to hire staff and implementing new technology to effectively deal with a large and complex industry. To that end, I have previously called for Congress to pass legislation establishing the SEC as a self-funded agency, similar to the way other financial regulators are funded — such as the Federal Reserve Bank, the FDIC, OTS and OCC. This would help to solve the problem.

To the extent that funds are registering and reporting to the SEC, I encourage Congress to couple the authority increasing the SEC’s jurisdiction with the appropriate self-funding mechanism to allow us to provide effective oversight.

This is not to say I am not against reasonable, reasoned and fiscally responsible oversight and regulation.  I believe that systemic stability is critically important for the long term viability of the hedge fund industry as well as the capital markets.  In this vein, I think that Aguilar’s statement below represents the type of structures which would contribute to increased stability while minimizing regulation where it is not necessary.

Perhaps a tiered approach to registration, based on a fund’s potential to affect the market, would make sense. At the lowest tier would be small funds. These funds could be subject to a simple recordkeeping requirement as to positions and transactions, kept in a standardized format, to permit the SEC to efficiently oversee their activities. As funds grow in size, different standards may be appropriate.

While I do not agree with many of the points regarding regulation the Commissioner discussed in the speech reprinted below, I do believe that the Commissioner does a good job at identifying issues which should be discussed publicly as regulators and industry participants move towards creating a reasonable regulatory regime.

Please feel free to include your comments below.


Speech by SEC Commissioner:
Hedge Fund Regulation on the Horizon — Don’t Shoot the Messenger

Commissioner Luis A. Aguilar

U.S. Securities and Exchange Commission
Spring 2009 Hedgeworld Fund Services Conference
New York, New York

June 18, 2009

Thank you for that kind introduction. I am pleased to be here with you at the Spring 2009 Hedgeworld Fund Services Conference. This conference is timely given the current discussion regarding potential regulation of the hedge fund industry. Let me say at the outset, as is customary, my remarks today are my own and do not necessarily reflect the views of my fellow Commissioners or of the Commission staff.

My experience with the securities industry began in the late 1970’s. After three years with the SEC, I’ve spent the bulk of my 30 years as a lawyer focusing on the capital markets. Most of those years where in private practices in large law firms, although I spent most of the 90’s and the early part of this decade as General Counsel and Head of Compliance of a large global asset manager. While I’ve spent much of my professional career involved in capital formation though public and private offerings, a substantial portion has been spent working in the investment management industry, and I have worked with hedge funds.

As we all know, there has been much speculation about the impact of hedge fund activity on the broader capital markets. For example, there are questions about whether hedge funds may have contributed to the market turmoil and how hedge funds may have contributed to the demise of Bear Stearns, Lehman Brothers and others. Additionally, it is also not clear whether the lack of oversight of the industry resulted in large amounts of risk to the market through the use of short sales and derivatives, such as credit default swaps.

This year’s conference takes place at a key moment in the history of hedge funds. While hedge funds have remained largely unregulated, this seems to be coming to an end. All over the world, legislators, regulators, investor groups, industry representatives and others are loudly calling for the industry to be regulated.

In the United States, the calls for regulation are motivated by concerns that market integrity has been harmed and that systemic risk arose as a result of the exemptions and exclusions from the federal securities laws that permitted a private market to thrive in ways that may have harmed the public markets. In fact, the market turmoil clearly demonstrated that the private fund market does impact the broader capital markets. This does not mean that all fund activity must be equally regulated, but hedge funds, especially large ones, are thought to require greater regulatory oversight.

My goal with my remarks today is to:

  • First, lay out a current state of affairs regarding the hedge fund industry;
  • Second, describe the calls for regulation of the industry; and
  • Third, discuss key considerations that need to be assessed as hedge fund regulation moves forward.

Multiple Voices Calling For Regulation

The hedge fund industry looks very different today than from where it started. Since the first hedge fund was organized by Alfred Jones in 1949 with $100,000, the industry has exponentially grown both in number of funds and in number of assets under management. In recent years, this growth has been fueled in part by institutional investors, such as endowments, foundations, insurance companies, and pension plans. To give you an idea of the growth, it is believed that the industry managed around $38 billion in 1990, $625 billion in 2002, and reached $1.9 trillion at the end of 2007, although that the number decreased to $1.3 trillion at the end of 2008. It is still incredible growth from the $100,000 start.

The industry’s growth, and the concerns over the impact of hedge funds on the marketplace, has created a renewed call for regulation in the U.S. and abroad. For example, the European Commission recently proposed to regulate the managers of hedge funds and all private equity funds with 100 million euros in assets under management. The proposed regulations would require extensive disclosure of risk management procedures and other aspects of fund governance.

In the U. S., a few years ago the SEC unsuccessfully attempted to regulate hedge funds. More recently, in March of this year, Treasury Secretary Timothy Geithner testified about his plan to more tightly oversee hedge funds. In addition, there recently have been at least a half-dozen bills introduced in Congress requiring regulation of the hedge fund industry. Just this past Tuesday, Senator Jack Reed introduced a bill that would require that advisers to hedge funds, and to certain other investment pools, to register with the SEC. And yesterday, of course, the Obama Administration released a draft white paper that, among other things, proposes that advisers to large hedge funds register with the SEC, and that very large advisers be subject to additional federal supervision by the Federal Reserve Board.

What are the concerns underlying the call for government oversight? I will tell you what we are hearing. The concerns touch on the classic financial regulatory interests: such as market integrity concerns, systemic risk concerns, and investor protection concerns. This state of affairs is what you would expect when markets are inextricably integrated and the impact of hedge funds is significant, but their actions and their risks are opaque. Simply stated, regulators, legislators and the public have little credible information as to who is out there and what they are doing.

Market Integrity Concerns

Let’s start with the SEC’s responsibility to maintain fair and orderly markets. One of the concerns about hedge funds involves how hedge fund operations impact upon the fairness and the integrity of the broader market. The lack of transparency and oversight over hedge funds gives rise to a number of concerns — for example, market integrity concerns about the nature and extent of counterparty risk, concerns about whether hedge funds engage in insider trading, and questions about how hedge funds drive the demand for derivatives, such as CDSs, as well as how they impact the demand for securitized products.

As a predicate for discussion, let’s be clear about the significant market activity of hedge funds. For example, hedge funds reportedly account for more than 85% of the distressed debt market, and more than 80% of certain derivatives markets. Moreover, although hedge funds represent just 5% of all U.S. assets under management, they account for about 30% of all U.S. equity trading volume. In 2006, there were estimates that hedge funds were responsible for as much as half of the daily trading volume on the New York Stock Exchange.

Because hedge funds are not subject to leverage or diversification requirements, hedge fund managers can more easily take concentrated positions that can impact the market. For example, an entire fund or even multiple funds advised by the same hedge fund manager can be invested in a single position.

In addition, hedge funds are major players in the capital markets for reasons other than trading activity. As this audience knows well, hedge funds have significant business relationships with the largest regulated commercial and investment banks — and act as trading counterparties for a wide range of OTC derivatives and other financing transactions.

Counterparty Risk Concerns

Clearly, for all these reasons and others, hedge funds are significant players in the capital markets. As significant players, hedge funds are one source of counterparty risk, and this risk can be amplified by their leverage and opacity.

Today, commercial banks and prime brokers are called upon to bear and manage the credit and counterparty risks that hedge fund leverage creates. Up until now, it has been assumed that market discipline would effectively prevent hedge funds from detrimentally impacting the capital markets or from posing systemic risk. A January 2008 GAO Report, however, identified several concerns with that theory.[1] For example, the report noted that hedge funds use multiple prime brokers and questioned whether any single prime broker has a complete picture of a hedge fund client’s total leverage. Accordingly, the stress tests and other tools that a prime broker uses to monitor a given counterparty’s risk profile only incorporate the positions known to that particular prime broker. Thus, no single prime broker has the whole picture.

The GAO Report also stated that some counterparties may lack the capacity to assess risk exposures because of the complex financial instruments and secret investment strategies that some hedge funds use.

Unfortunately, the GAO Report also indicates that counterparties facing these structural limitations may have also actively relaxed credit standards in order to attract and retain hedge fund clients in response to fierce competition.

In each of these instances, the risks of hedge funds are being externalized to the regulated market — prime brokers, banks, and their shareholders each were asked to bear the costs of managing hedge fund risks. A concrete example you may remember was when two Bear Stearns-sponsored hedge funds collapsed in 2007. Merrill Lynch, one of the prime brokers, had to absorb an enormous loss because it could only sell the funds’ collateral for a fraction of its purported value.

It’s been obvious that the regulatory oversight of hedge funds has not matched their level of market activity. This difference has led to other concerns affecting market integrity.

Risks of Insider Trading Create Market Wide Concerns

For example, in addition to concerns about counterparty risk, there have also been concerns about hedge funds engaging in insider trading. Clearly, there has been an increase in the number of insider trading cases brought by the Commission that have involved hedge funds. Admittedly, it is incredibly difficult for the Commission to assess the frequency of insider trading because of the opacity of hedge funds and the investments they make, especially in OTC derivatives. Moreover, when you couple this with the fragmented nature of the securities markets and the broad potential for hedge funds to obtain inside information, it is a tough oversight situation indeed. Hedge funds who participate in private placements, talk with trading desks, and maintain connections with the street are, in many cases, in a position to obtain inside information and to use it in a way that traditional surveillance may not detect. This potential for insider trading has been well publicized and public investors are concerned about the possible effects on market fairness and integrity.

Hedge Funds And The Demand For CDS and Securitized Products

Additionally, hedge funds were significant players in the exponential growth in the now much maligned credit default swaps market. As the market to create CDSs grew, there were funds that bought these instruments for reasons that made sense. For example, in 2005 there were hedge funds who noticed that the U.S. housing market was weakening and they bought CDS instruments on the protection buyer side. A logical move.

On the other hand, it is well known that the credit risk reflected by CDSs is equal to multiples of the actual credit risk of the underlying bond market. How did that happen? Many CDSs were heralded as hedging tools — they were supposed to transfer risk to parties that could bear it from parties that could not. Now we see only too clearly that this was not the case. Instead, many CDSs actually created risk, rather than hedged risk. Hedge funds that sought to create profits from leveraged risk may have played a crucial role driving the growth in these products.

Systemic Risks

The concerns about hedge funds and market integrity often go hand in hand with concerns about systemic risk. In their current form, hedge funds pose a systemic risk threat to our financial system in several ways. First, hedge funds have such significant assets under management that some fear that the loss of one or more large firms could potentially reverberate throughout the capital markets. In addition, if a counterparty fails to effectively withstand a hedge fund loss, then the failure of the counterparty could itself threaten market stability.

There is also the issue that can occur when several hedge funds take the same position, whether through coordination or simply through similar trading strategies. These funds can have a large impact on the market when they adjust their positions en masse.

Thus, the concerns that the lack of oversight over the hedge fund industry may present to market integrity and to systemic risks seem to be well founded.

Investor Protection

In addition to concerns about market integrity, the SEC is also responsible for investor protection. Given the increase in complaints from hedge fund investors this has taken on a more immediate importance.

One of the underlying principles behind the idea that hedge funds could operate with little to no regulatory requirements was that interests in the funds were only sold in private offerings to wealthy investors. These investors were thought to be sufficiently “sophisticated” to protect their interests, and to be able to engage in effective arms-length negotiation in order to achieve fair and equitable terms.

I firmly believe that truly sophisticated investors in private deals should be held accountable to the terms that they knowingly negotiate — and if an investment were to go bad, they should bear the loss.

However, with the recent market turmoil and the ongoing economic upheaval that has caused trillions in wealth to vanish, millions of jobs to disappear and the liquidation of over 1,500 hedge funds, serious concerns have been raised about whether these wealthy and sophisticated investors are truly able to protect their interests. There seems to be evidence that these “sophisticated investors” may not have fully appreciated the risks they were taking. Perhaps it may make sense for the definitions of who qualifies as “sophisticated” under our rules to be reconsidered. For example, maybe the criteria for sophistication should focus on more relevant attributes — such as focusing on actual investment experience.

In any case, recent events have challenged the assumption that investors and market discipline can be relied upon to control the risks of hedge funds. And this is not surprising. First, these investors are typically passive and there is no legal obligation for hedge fund investors to monitor hedge fund activity. Second, even if investors wanted to actively monitor the investment, the nature of hedge fund activity and the information available may not currently support such a role.

Valuation and Performance

For example, it may be impossible for an investor to know the actual value of a hedge fund’s portfolio. Hedge funds are not subject to reporting requirements and because many instruments held by a hedge fund are illiquid or opaquely-priced OTC products, any information that is reported could be hard to evaluate.

Related to the concern of how a fund values its assets, is a hedge fund’s performance information — another hard to evaluate metric for investors. Without regulation, the only performance information that hedge funds provide is voluntary.

This quote by Harry Liem, a pension consultant, seems to sum it up when he said “It’s like someone walking into a casino and saying ‘I want everyone to come forward and tell me how much you have won or lost.’ Probably only the winners will come forward . . .”[2]

Not Being Able to Redeem

There is also the issue of investors not being able to redeem their investments from a fund. In recent times, due to the large amount of redemption requests and the current lack of an ability to raise cash, there are hedge fund managers who have put up gates and have restricted investors’ ability to redeem their monies. Although gates can benefit investors by giving the manager more time to sell off portfolio positions, for some investors it appeared to be a surprise.

On top of that, several hedge fund managers froze funds but continued to charge management fees on money that investors cannot access. Orin Kramer, a hedge fund manager, described the situation by stating: “It’s like telling someone at a hotel that they can’t check out and then charging them for the privilege of staying.”[3]

Let me be clear. I’m not saying that these situations are per se illegal. To the extent that sophisticated and qualified investors agreed to provisions providing for gates and the ongoing charge of management fees, one could say that investors walked into these agreements with open eyes.

However, because for the most part hedge funds are not registered with the SEC, we are not able to adequately oversee how they are operating. Moreover, this lack of transparency makes it difficult to assess whether the relationship between an investor and the hedge funds adviser, is functioning in the manner that underlie the presumptions that led to the exemptions.

Some recent reports do tend to show that investors are beginning to take their own initiatives, and give some indication that what investors may be willing to agree to in the future may be different. For example, a recent memo from CalPERS stated that it would no longer partner with managers whose fee structures result in a clear misalignment of interest between managers and investors. Moreover, more investors are now asking that hedge funds run assets in “managed accounts,” where their money is held separately and the holdings are transparent.

As you may expect based on concerns including ones I have mentioned, hedge fund investors have been calling the Commission in unprecedented numbers

Increased Cases Involving Hedge Funds

In fact, the Commission has more investigations involving hedge funds than ever before, and the number of cases actually brought also is increasing. In the first 4 months of 2009, the Commission filed 25 cases related to hedge funds. In contrast, we brought 19 cases in all of 2008, 24 in all of 2007, and 16 in 2006. Our cases cover the waterfront, charging everything from offering fraud and insider trading, to misrepresentations about performance and to misrepresentations about the actual due diligence undertaken. We are also seeing more cases involving conflicts of interest and outright theft of assets

Nature of Regulation

I have just laid out for you some of the concerns that are generally driving the calls for greater regulation and oversight of the hedge fund industry. Maybe even more important, it appears that some of the assumptions justifying the industry’s exclusion from regulation and oversight may be on faulty ground. As a result, it seems certain that regulation of the hedge fund industry is coming. But here is the harder question — what should it look like?

There are a number of questions as to exactly how, and to what extent, hedge funds may have contributed to the economic crisis and how they contributed to the overall systemic risk of the financial markets. To that end, I applaud Congress and President Obama for providing for an independent, bi-partisan Financial Crisis Inquiry Commission. By investigating and analyzing what happened, we can better assess whether the regulatory proposals should move forward.

Since coming to the Commission, I have been a vocal advocate for the Commission’s mission to protect investors, provide for fair and orderly markets, and promote capital formation. All aspects of this mission guide my thoughts as we consider the appropriate framework to regulate hedge funds.

Because of the size, complexity and market-wide impact of the hedge funds industry, potential regulation would need to be both comprehensive and flexible. Something not always easy to achieve.

I believe that the SEC must be an active participant in this process. Please remember that the SEC has been overseeing industry participants — such as, investment companies, investment advisers and broker-dealers — for over 69 years. The Commission staff has unsurpassed expertise in this area. Congress should take advantage of this expertise by providing the Commission with a broad mandate to oversee hedge funds. The Commission could then scale its regulation in a flexible manner to deal with the regulatory concerns of market integrity, investor protection, and, in coordination with other regulators, systemic risk.

Working with hedge fund advisers and with hedge fund investors, I am confident that we can find an appropriate balance.

As you know, there has been a general discussion over whether hedge fund advisers and/or hedge funds should register. In my mind, hedge funds advisers with over $25 million in assets should register with the Commission, but that may not be enough. Many hedge fund advisers are currently registered with the SEC but we still lack a complete picture of what is going on in the industry. Some have suggested that hedge funds should also register. Others have suggested that it may be appropriate to apply limited concepts from within the Investment Company Act of 1940 to hedge funds — what some have called a “40 Act-lite” regime.

Perhaps a tiered approach to registration, based on a fund’s potential to affect the market, would make sense. At the lowest tier would be small funds. These funds could be subject to a simple recordkeeping requirement as to positions and transactions, kept in a standardized format, to permit the SEC to efficiently oversee their activities. As funds grow in size, different standards may be appropriate.

For funds that could significantly affect the market, it may be appropriate to require more than recordkeeping. For example, it may be appropriate to think through whether some of the risk limitation concepts built into the Investment Company Act make sense to apply to these hedge funds — such as imposing limits on leverage.

Of course, these are only a few suggestions. Many others have been made — and others will follow — as the discussion turns from “whether to regulate” to “how to regulate.” The nature of the business of hedge funds is trading, and this necessarily requires interaction with the public marketplace — and the larger the investment fund, the greater the potential impact on the overall capital markets. When the hedge industry has the ability to significantly impact the market or other market participants, the public interest needs to be protected. A lesson of this economic crisis is that the U.S. regulatory interest in hedge funds arises because of the impact of the funds on the financial market, regardless of the sophistication of its investors or the number of investors.

When discussing “how to regulate,” it is clear to me that regulation is more than the bare requirements of registering and reporting — it should also include inspection authority. To have a chance to prevent problems before they occur, the SEC has to be able to inspect all hedge fund advisers, and the funds that they manage, and otherwise engage in oversight through surveillance systems. The public expects nothing less.

Greater Resources to SEC to Provide Effective Oversight

As we talk about regulation of the hedge fund industry, there is also the question of regulatory resources. Any future registration of hedge fund advisers and/or hedge funds will require that the SEC receive increased resources to provide effective oversight. We will need to hire staff and implementing new technology to effectively deal with a large and complex industry. To that end, I have previously called for Congress to pass legislation establishing the SEC as a self-funded agency, similar to the way other financial regulators are funded — such as the Federal Reserve Bank, the FDIC, OTS and OCC. This would help to solve the problem.

To the extent that funds are registering and reporting to the SEC, I encourage Congress to couple the authority increasing the SEC’s jurisdiction with the appropriate self-funding mechanism to allow us to provide effective oversight.


In conclusion, I am confident that regulation of the hedge fund industry can be done right — in a way that balances the needs of the industry with the needs of investors and the needs of the market. And if it is, it will be a good thing for all of us. The Congressional Oversight Panel’s Special Report on Regulatory Reform4 said it best with the following summary:

“By limiting the opportunities for deception and allowing for the necessary trust to develop between interconnected parties, regulation can enhance the vitality of the markets. Historically, new regulation has served that role.
For example, as the money manager Martin Whitman has observed, far from stifling the markets, the new regulations of the Investment Company Act enabled the targeted industry to flourish:

“’Without strict regulation, I doubt that our industry could have grown as it has grown, and also be as prosperous as it is for money managers. Because of the existence of strict regulation, the outside investor knows that money managers can be trusted. Without that trust, the industry likely would not have grown the way it had grown.’”[5]

The lack of transparency, potential imbalance of power between investors and managers, and impact on the entire capital market are driving the calls to regulate the hedge fund industry. The hedge fund industry has a lot to offer in determining how these calls are answered. Addressing these issues in an intelligent and rational manner is important, and ultimately will result in a stronger and more vibrant hedge fund industry. I welcome the ongoing discussion.

Thank you for inviting me here today.


[1] GAO Report: Regulators and Market Participants Are Taking Steps to Strengthen Market Discipline, but Continued Attention is Needed. January 2008. pg 27.

[2] Why people love to hate those risky hedge funds; An investment option that only the super rich can afford, by Naomi Rovnick. South China Morning Post Ltd. March 1, 2009.

[3] Hedge Funds, Unhinged by Louise Story. New York Times. January 18, 2009.

[4] Congressional Oversight Panel’s Special Report on Regulatory Reform: Modernizing the American Financial Regulatory System: Recommendations for Improving Oversight, Protecting Consumers, and Ensuring Stability. January 2009. pgs 18-19

[5] Letter from Third Avenue Funds Chairman of the Board Martin J. Whitman to Sharheolders, at 6 (Oct. 31, 2005) (online at www.thirdavenuefunds.com/ta/documents/sl/shareholderletters-05Q4.pdf).



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