Review: Is Hedge Fund Registration Necessary?

In 7s Hedge Fund Adviser Registration Necessary To Accomplish the Goals of the Dodd-Frank Act's Title TV?,1 Luke Ashworth sets out a formidable case that questions the grounds for the mandatory hedge fund registration requirement contained in the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act).2 This review of his Note will offer a description of the piece's key strengths, suggest some challenges to the solutions it offers, and close with suggestions about areas that might build on Ashworth's work in future scholarship.I. ReviewA. The ArgumentAshworth lays out a well- researched background of the history of the hedge fund industry, prior attempts to regulate the industry, and the complex regulatory regime that previously exempted the industry from mandatory registration which was amended by the Dodd-Frank Act.He explores the underlying justification for the mandatory registration rule by describing hedge fund crises at Long-Term Capital Management in 1999 and two Bear Stearns hedge funds during 2007. He notes how the drafters of the hedge fund registration rule were motivated by a desire to prevent investor fraud and to minimize and monitor systemic risk.Ashworth's skepticism of the mandatory registration requirement as a response to the financial crisis is even stronger than he suggests. The Financial Crisis Inquiry Commission's (FCIC) Final Report on the Causes of the Financial and Economic Crisis in the United States mentions hedge funds quite infrequently, and even when it does so it does not describe their involvement in any way that would support the mandatory registration provision.3 While hedge funds were active participants in markets for asset-backed securities that quickly lost value in the financial crisis,4 it is unclear that they were more aggressive than other investors. Indeed, many hedge funds also took short positions in real estate- derived assets, and companies invested in them, that can be credited with popping the asset bubble before it grew even bigger.5It is also unclear how registration would have affected those funds that played a role in the asset bubble. For example, the FCIC Report examines the role of "hedge funds" at Bear Stearns that had significant positions in mortgage-backed securities, which ultimately brought down the investment bank in 2007 and eventually led to the government-facilitated takeover of the bank by JP Morgan in 2008. 6 But Bear Stearns was not an unregulated entity - in fact it was much more heavily regulated under the Security and Exchange Commission's (SEC) Consolidated Supervised Entity (CSE) capital regulation program than the investment adviser registration regime that hedge funds will be subject to post-Dodd-Frank.7Ashworth accepts that large hedge funds had a prominent role in the financial crisis but argues that the registration requirement is overbroad from an alternative perspective. Ashworth effectively demonstrates that the redundancy created by Dodd-Frank, in which both the Office of Financial Research (OFR) under the Financial Stability Oversight Council (FSOC) and the SEC will serve as information coordinators, will not aid systemic risk oversight and may cause its own problems. The reader is left convinced that information-reporting requirements, for the same purpose but from different regulators, will compound compliance costs and may even create mutually inconsistent reporting requirements.If systemic risk is the issue, it is unclear whether and to what extent creating multiple information-collection entities, in both the SEC and the OFR at the Treasury Department, will provide additional value. Where the OFR will be able to coordinate with the FSOC, charged with systemic risk determinations, the SEC will be a step removed from the central decision-making and will have to coordinate through multiple layers to obtain useful information. Redundancies in this area will not be costless, but will add multiple layers of compliance requirements and multiply the risk that proprietary trading information will be revealed to market competitors. …