As state lawmakers debate legislation that would place tighter oversight on hedge funds, most agree that regulation over the industry should come from the federal government.
“Just as a matter of principle I think state regulation of financial institutions is not a good idea,” said U.S. Rep. Jim Himes, (D-Greenwich) a member of the financial services committee on Capitol Hill and a former Goldman Sachs employee. “We need greater uniformity and simplicity in regulating the system and I think it should come from the federal government.”
Walter Dolde, a finance professor at the University of Connecticut’s School of Business in Stamford, agrees.
“The federal government has a greater amount of technical expertise available to them,” Dolde said. “Interstate commerce would be a nightmare with 50 different regulatory regimes.”
Even key state lawmakers on the legislatures’ banks committee and Attorney General Richard Blumenthal agree that federal measures are preferable, but they have introduced a myriad of bills to regulate the industry anyway, believing they can no longer wait for the federal government to act.
Their proposed legislation would require each hedge fund to obtain a state license, provide for an independent annual financial audit and disclose fees and significant changes in management or management strategy.
Largely unregulated
Most of the concepts raised in the bills were proposed in 2007, but they died on the floors of the House and Senate, because lawmakers were skittish about being the only state to impose such tight restrictions and because they were under the impression that Congress would pass similar legislation.
That never happened, and hedge funds have remained largely unregulated since that time. Now the industry has come under renewed criticisms and stress, taking partial blame for the financial crisis and suffering nearly $530 billion in losses last year.
State officials are facing increased pressure to protect investors, but once again the federal government has pledged to take action.
The stakes are high for the state since Connecticut is home to hundreds of hedge funds that contribute tens of millions of dollars to the state economy. Imposing tight restrictions on those funds could drive some of them out of the state.
“Federal regulation will come soon, but not soon enough,” Blumenthal said at a Feb. 27 public hearing at the state capitol. “National standards and rules are appropriate because federal agencies have the resources and expertise as well as the authority to make enforcement effective. But, in the current regulatory back hole, states must act.”
Blumenthal explains that the proposals seek to establish a regulatory framework and investor protections. He said hedge funds create the potential for systemic risk through the use of leveraging and debt devices which make them susceptible to market shifts.
He said the state can play a leadership role in regulating the industry, which is important because it is no longer just the wealthy and sophisticated investors who have a stake in it; increasingly charitable institutions, school endowments and pension funds are investing in hedge funds as well.
Absent of federal regulation, Himes agrees that it might be a good idea for states to act.
Himes also said that President Obama has asked the financial services committee to develop a regulatory system that would monitor the levels of leverage used by hedge funds.
Such a regulatory body would require hedge funds to provide more transparency and disclosure to investors, Himes said.
Federal lawmakers have also proposed a bill that would require funds to begin filing information with the Securities and Exchange Commission.
Himes said, however, he couldn’t guarantee that either of them would happen, but that it’s a topic he’s personally focused on.
Greg Bordonaro is a Hartford Business Journal staff writer.
