Despite the midterm election shakeup, Washington-watchers expect very little new legislation affecting the fund industry to shake out of Congress before 2008.
Absent a major financial services scandal, experts expect legislators to commission studies and deliberate issues surrounding financial services, but leave the rulemaking to regulators.
"This is definitely a place for oversight, hearings and debate," said Mike Townsend, vice president for legislative and regulatory affairs at San Francisco-based Charles Schwab, of the incoming 110th Congress.
Even with Democrats taking the reins from Republicans on both the House Committee on Financial Services and the Senate Committee on Banking, Housing and Urban Affairs, experts predict a relatively quiet ride for the fund industry. Such inactivity may come as a relief after the ruckus raised by the 2002 Sarbanes-Oxley Act, the flurry of regulations that followed the mutual fund scandals of 2003, and, most recently, yelps for help from those who worry hedge funds are putting Americans' pensions at risk.
"The financial world is more complex than most politicians are able to understand," said Nomi Prins, a senior fellow at New York-based, nonpartisan public policy think tank Demos and author of several books about Wall Street. Particularly in this time of scandal-free and relatively strong markets, additional legislation is unlikely, she added.
In part, that may be because that Democratic majority is such a slim one, especially in the Senate, where it's 49-51. Two of those 51 caucusing Democrats-Joseph I. Lieberman of Connecticut and Bernard Sanders of Vermont-are actually Independents.
Furthermore, the incoming Democratic chairmen of these crucial committees are more moderate than some may think. Barney Frank (D-Mass.), who will replace retiring Michael G. Oxley (R-Ohio) on the House committee, did introduce legislation requiring hedge fund advisors to register with the Securities and Exchange Commission after the regulator's own bill was tossed out by the courts; however, he has since backed off the bill, requesting a study, instead.
Chris Dodd (D-Conn.) is expected to replace Richard Shelby (R-Ala.) as head of the Senate Banking Committee. During the mutual fund scandals, Dodd spoke out for consumer education and improved disclosure. Those with their eyes on the Hill expect more calls for retail investor-friendly initiatives, but not necessarily new laws.
Another influence will be the districts each represents. "The constituencies in Massachusetts and Connecticut will probably be pretty important in shaping their views," said Neils Holch, executive director of the Collation of Mutual Fund Investors in Washington.
The two New England states are home to a number of financial services firms. In Connecticut, Dodd represents the so-called insurance capital of the world, Hartford, while down in the opposite corner of the state, scores of hedge fund shops, as well as several back-office operations of big investment banks, call Greenwich and Stamford home.
Frank's district, centered around Newton, Mass., hugs the western border of Boston, the headquarters of many mutual fund complexes and fund administration firms.
If this Congress highlights any type of balance, experts say, it won't be one between Democratic and Republican, liberal or conservative, control, but rather the balance between legislators and regulators. And if anyone is coming out with new rules in the next few years, it will likely be the SEC, said David Lerner, a partner with Morrison Cohen, in New York.
A former Republican U.S. Congressman, SEC Chairman Christopher Cox has made clear his concerns that hedge funds represent a regulatory miasma that needs clearing up.
"The SEC definitely wants to rebound from [the court's decision to overturn the registration rule], just to show it can, and it's going to want to do that by adopting new regulations," Lerner said.
But unlike the hedge fund registration rule, he said, "They will adopt rules they think will actually work, and not try to overreach."
One likely attempt will be a rule raising the minimum qualifying standards for those interested in investing in hedge funds.
"Most people in the industry recognize that the standard adopted back in 1982 is out of date," said Richard Goldman, who spearheads the hedge fund practice and is a partner with Bingham McCutchen in Boston.
Designed to protect inexpert investors, the law restricts hedge funds from accepting investments from those with a net worth of less than $1 million or an income lower than $200,000 per year. Twenty-five years, some significant inflation and a big economic growth spurt later, millionaires are a dime-a-dozen demographic, and the high bar for protection is considered pretty low.
Another group that legislators and regulators alike have voiced protectionist concerns about are participants in pension funds.
"What gets politicians all excited is when a pension plan loses a bunch of money," Lerner said. The most recent example is that of Amaranth Investors, the Greenwich, Conn.-based hedge fund that made a bad $5 billion bet on natural gas. San Diego County Employees Retirement Association was cited as one of the hardest hit pension plans. Losses amounted to $105 million, or 1.4% of its $7.7 billion worth.
At the same time, the SEC has begun examining a rule change proposed by the New York Stock Exchange that would allow hedge funds, and other wholesale investors, greater leverage by relaxing restrictions limiting the amount that stocks can be traded on margin-presently 50% compared to 95% for other tools-and increasing the types of products to which margin options can be applied. Submitted by the NYSE in January, the rule still has several hurdles to overcome before it is fully approved. But in a market-oriented move on July 11, the SEC approved one segment-portfolio margining-expanding the list of eligible products to include securities futures contracts and listed single stock options on a trial basis, expiring July 31, 2007.
"Hedge fund managers, as a rule, they love it, as long as it works," Lerner said. That's because relaxing margin restrictions offers far greater leverage and a whole host of opportunities to apply alpha-generating techniques.
On the mutual fund front, Holch hopes for more specific, and stringent, rules surrounding omnibus accounts, bundling of trades and market timing. He cited a persistent lack of transparency, which can help shield market timers and late traders. "I would hope the [legislative] committees would continue to oversee and help nudge the commitment of the SEC on those issues," he said.
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