Phillip Goldstein, the hedge fund manager and self-professed shareholder activist and partner of Bulldog Investors of Pleasantville, N.Y., is set to duke it out again with the Securities and Exchange Commission in a battle that could eventually lead all the way to the Supreme Court.
Goldstein prevailed this past June in a high-profile lawsuit that challenged the regulator's hedge fund manager registration rule that took effect this past February. A court of appeals in Washington sided with Goldstein and vacated the SEC-promulgated rule requiring hedge fund managers to register with the SEC and follow compliance procedures.
This time, Goldstein will challenge rule 13f of the Investment Advisor's Act of 1934. The rule requires institutional investment managers, whether they are registered with the SEC or not, to periodically provide a full list of certain equity holdings including short positions to the regulator once discretionary assets hit $100 million or more. What the SEC does with this information is anyone's guess, said Goldstein, who bumped into that rule this year when assets under management in one hedge fund he runs exceeded the $100 million threshold.
The concern among many hedge fund managers is that once this information is in the public realm, copycats will analyze and mimic their strategies, thereby diluting their value to investors.
Goldstein believes that the 30-year-old law is not only unwarranted, but forces hedge fund managers to divulge "trade secrets." The original intent of Congress' 1975 adoption of the rule was "to fill an information gap about the activities of institutional managers" that the SEC claimed it needed to devise regulations, Goldstein claims. However, the data has never been used in this manner, he said.
Moreover, Goldstein alleges that the law is unconstitutional on the grounds that it violates the Fifth Amendment to the U.S. Constitution. While the Fifth Amendment is best known for its protection against both self-incrimination and "double jeopardy," or being tried twice for the same offense, it also addresses the issue of "eminent domain" in which "private property [shall not] be taken for public use, without just compensation."
Goldstein believes Rule 13f tramples his Fifth Amendment rights, claiming his "trade secrets" are legally considered private property. The law requires investment managers "to place their trade secrets in the public domain without any intent to pay them just compensation,'" Goldstein argued in an exemption request he plans to file with the SEC. "This represents a potentially unconstitutional taking,'" he said.
Goldstein announced his intent to again challenge the SEC at a New York media conference held last week, sponsored by consulting firm Millennium Media of Alexandria, Va. Goldstein said that within 30 days, he will seek SEC exemptive relief regarding Rule 13f.
Early indications are that the SEC will deny Goldstein's exemption request, a mandate that Goldstein will have to abide by as of Feb. 14, 2007. If denied, Goldstein said he plans to first request a hearing with an SEC administrative judge, then potentially sue the regulator, although the particulars haven't been decided.
"Just as we [as activist shareholders] don't tolerate management abusing shareholders, I don't think any citizen should tolerate a Federal agency abusing its authority," Goldstein said. "We have good investment ideas, and we don't want them publicly out there. I have a fiduciary responsibility to [my] investors."
Goldstein likens the requirement of having to divulge his securities holdings to a restaurant whose chef has to publish his best recipes once the restaurant achieves a certain level of revenues. "Disclosure sounds good, but what we're really talking about are trade secrets," he said.
The SEC has been viewed as being vulnerable in recent times. In June, it lost its bid to impose hedge fund manager registration rules, and two months earlier, it was admonished by the same court of appeals for not affording an opportunity for the public to comment on or understand the cost of requiring mutual fund boards to be run by an independent board chairperson.
"Hedge fund managers gripe about this disclosure all the time," said Tim Selby, a partner with the New York office of the law firm Alston & Bird. "There's been no change in the rule [13f] in 30 years. The $100 million threshold will capture a lot more hedge funds today especially since there are a lot more hedge funds than ever before," he said. Perhaps the law should be amended to increase that $100 million threshold, or so that it applies only to publicly available, open-end investment companies, such as mutual funds, he commented.
"The statute does require the filing of the reports, so there's not a lot of room for the Commission to say, never mind,'" said Elizabeth Fries, a partner and head of the hedge fund practice in the Boston office of the law firm Goodwin Procter. The Commission is required to collect the information, but they don't necessarily have to make it readily available to the public, she said.
The Commission has procedures, under The Freedom of Information Act, for filings to be made in a confidential manner so long as filings are made on time, said Michael Tannenbaum, a partner with the New York law firm of Tannenbaum, Helpern Syracuse & Hirschtritt.
"Most managers aren't terribly opposed to disclosing securities held on the long side but are sensitive to disclosing the short-side ones," as these can tip a manager's hand, he said. The issue here is what kind of property can be taken within the meaning of the Fifth Amendment, Tannenbaum added.
The Supreme Court's June 23, 2005 decision to relax the standards under which eminent domain property can be taken makes the property distinction "less obvious," he added.
"You have to balance the purpose of the rule with the alleged loss of rights to the petitioner," said Carl Frischling, a partner with the New York law firm of Kramer Levin Naftalis & Frankel. "I think Goldstein has an uphill battle in fighting the very essence of 13f filings."
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