WASHINGTON - Lawmakers appeared skeptical of the need to bring hedge fund products to retail investors as Securities and Exchange Commission Chairman William Donaldson presented the agency's findings from its hedge fund roundtable.

In his first address to the House Financial Services Capital Markets Subcommittee, Donaldson also hinted at the need for hedge fund regulation, telling lawmakers that the industry is too big for regulators not to know more about it. The industry in the U.S. is estimated to have between 6,000 and 7,000 hedge funds with $650 billion in assets under management, Donaldson said. "We need to know more about what's going on inside some of these funds," he said.

Mystery surrounds the product so much so that Donaldson told the subcommittee that one of the biggest obstacles to potential regulation is a lack of definition of the product. The lack of clarity is due to the absence of an industry-wide definition of the term "hedge fund" and the fact that those companies that track hedge fund data rely on self-reporting by the funds. Donaldson also said since hedge funds are not required to register with the SEC, the regulators cannot independently track data.

"For a large portion of hedge funds, we do not have the right to go in and see what they're doing," Donaldson said, noting that the SEC might want to check on how the fund is valuing securities, how it is organized, and to check its books and records.

"I'm not sure we'll ever come up with a definition that is broad enough and meaningful enough," Donaldson said, noting that the term hedge fund is undefined in federal securities laws. He said "hedge fund" has developed into a catchall classification for many unregistered, privately offered, managed pools of capital. This generally excludes funds principally involved in venture capital. "This is a far cry from the original concept of hedge funds in the early 1950s, when hedge funds characteristically were long/short equity funds that engaged in fundamental hedging strategies," Donaldson said.

During the roundtable and its ongoing fact-finding mission, the SEC obtained and reviewed information from 67 different hedge fund managers representing over 650 hedge funds and $162 billion in assets under management. The discussions centered around transparency and protecting investors, as well as the potential retailization of hedge fund, or hedge fund-like products (see MME 5/26/03).

"If hedge funds performed like mutual funds have over the last three years, hedge funds would be out of business," John F. Mauldin, president of Millennium Wave Investments in Fort Worth, Texas, testified before the subcommittee. "The positive values that hedge funds offer to rich investors should also be offered to the middle class, with a proper regulatory structure. The current two-class structure limits the investment choices of average Americans and makes the pursuit of affordable retirement more difficult than it should be. Why should smaller investors be prevented from sitting at the same table as richer investors?" Mauldin said.

"Investors in Botswana have better investment choices than those in Baton Rouge, LA," Mauldin told subcommittee chairman Rep. Richard H. Baker (R-La.). However, lawmakers seemed less receptive to the idea of the retailization of hedge funds than some of the panelists. "Everyone wants to defend their home, but its another thing to give a loaded handgun to a six-year-old," Baker said.

Congressman Michael Oxley (R-Ohio) also said that while hedge funds are a vital part of the capital structure and a valuable alternative investment, "they are sophisticated instruments designed for sophisticated investors. Hedge funds-of-funds have been only selling to institutional investors because they are not interested in the retail investor, not because they are barred from doing so," Oxley said.

"Why are we so interested in bringing this to the retail investor?" asked Rep. Paul E. Kanjorski (D-Pa.). "It's not the role of capitalism. I don't want middle-class families betting their kids' college education or their retirements in hedge funds."

Donaldson also told lawmakers here that regulators are examining the lack of disclosure of incentives given to broker/dealers selling certain mutual fund products.

"We are currently looking at sales practices of mutual funds within the broker/dealer community," Donaldson said. He said the commission is investigating whether certain incentives are being disclosed properly and if those practices violate the law or the spirit of the law. "There is disclosure, but it is more in the way of subtle incentives to get a broker/dealer to sell a certain fund," Donaldson said.

At issue is whether broker/dealers who stand to profit from the peddling of certain fund products they sell, are telling investors of the potential conflict of interests. Donaldson also said that revenue-sharing agreements are a "piece of information a perspective buyer has a right to know."

Copyright 2003 Thomson Media Inc. All Rights Reserved.

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