Why Register Hedge Fund Advisers—A Comment

I. IntroductionLuke Ashworth has weighed in as a young legal scholar on a subject of exceeding complexity and importance.1 His work does what a good Note should do in being well-organized, clearly written, providing useful background, engaging existent literature, and advancing (and supporting) a thesis grounded in policy considerations. And Luke's point of view is as unmistakable as it is provocative: the much-ballyhooed regulation of hedge fund advisers adopted in the landmark 2010 DoddFrank legislation2 is wasteful, unnecessary, and should be modified.Let me welcome Luke to the scholarly world, and extend to him the customary return for thoughtful work: a response. My remarks are designed less to offer critical comments than to place his subject and his views into a larger context, and to offer my perspective on why in 2010 we got the fund adviser law we did, and how that law illuminates larger and longstanding concerns about the sometimes incongruent investor protection, capital formation, and public interest goals of U.S. financial regulation.II. Investor ProtectionLuke faults the investor protection rationale underlying the hedge fund adviser registration and disclosure requirements of Dodd-Frank. He points out that there was already a Securities and Exchange Commission (SEC) anti-fraud rule, adopted in 2007,3 and that hedge funds supposedly draw sophisticated investors who can fend for themselves.4 I think the investor protection case for the registration requirement is a bit stronger than Luke believes, although that in turn serves to highlight in the fund area a question that long has loomed over federal securities regulation more generally: does mandated information disclosure always protect investors, is that its real goal,5 and is advancing that objective always consistent with other worthy policies? But before briefly making a few points about investor protection, let me address the seeming incongruity of the traditional investor protection aim of federal securities law generally with the specific concerns of Dodd-Frank and the acute financial crisis that preceded it.The reason for joining longstanding SEC concerns about investor protection with the sprawling systemic-financial-risk regulation of Dodd-Frank is hidden in plain view early in Luke's paper. Prior to Dodd-Frank, the SEC had failed for some time in its efforts to regulate investment pools and their advisers, as it consistently espoused investor protection in its quest to do so.6 The horrific 2008 crisis, viewed on this issue alone, was an unexpected and serendipitous regulatory opening, a crisis not to be wasted by a frustrated administrative agency. After all, more stringent securities market regulation typically is not adopted in booming and flush times; it follows on the heels of financial distress and can be overbroad and too far sweeping.7 In the aftermath of the historic financial meltdown of 2008-09, with victims and villains aplenty, and regulatory nuance in short supply - in contrast to the abundant regulatory shame - who could be opposed to better investor protection, whether or not faulty protection of hedge fund investors had really contributed to the crisis or, by being improved, would prevent another? For the SEC, the regulatory iron in Congress was hot and so the agency opportunistically struck, but for a cause it had sought long before our recent calamity.8 Luke rightly seeks in vain for the connection between the 2008 crisis and the need for fund adviser registration on investor protection grounds because there likely is none. If protection for investors was needed, it was in spite of, not because of, the crisis. But calculated timing and implausible policy connection to crisis aside, maybe there still is something to be said for better protecting fund investors.Hedge funds and their advisers almost invariably are organized as limited partnerships or limited liability companies.9 Whether organized in a state in the United States or under the law of the Cayman Islands, hedge fund vehicles are not stringently regulated under any of these laws. …