Requiem for California's Attempt at Hedge Fund Regulation

You have to give regulators an “A” for effort. We’re not totally anti-regulation at AllAboutAlpha.com. But we do find in curious how most, if not all, attempts to regulate hedge funds seem to have eventually come to a crashing halt.

The SEC set the example with its attempt to make hedge fund register back in 2006. Now the California Department of Corporations’ attempt to register hedge funds seems to have also met an untimely demise. HedgeWorld chronicles the whole sorry affair in detail…

As HedgeWorld points out, the proposed regulation would have required all funds not already voluntarily registered with the SEC to register with the Golden State. But to its surprise, the government of California found out that hedge funds would just leave the state to avoid the hassle (who could have known, really…).

In what appears to be a move to save face, California government officials said that “in light of the ongoing actions of federal regulators,” they would hold off on any further action on the regulatory front. Apparently, new regulations were “premature.” (Indeed, the time to drive hedge funds out of your state is later, not now.)

This would all make sense if it weren’t for the fact that federal regulators don’t actually have much happening the way of “ongoing actions." They too abandoned their registration plan a couple of years ago and instead enacted a rule that simply made it officially illegal to break the law (see related posting). Maybe the Californian regulators where talking about some other “federal regulators” - like the federal regulators in Myanmar or something.

In a related item, SEC commissioner Paul Atkins is resigning from the commission last week. For more on Atkins - including his dispassionate and balanced view of hedge funds - see our posting on the SEC meeting during which the latest super-watered-down version of hedge fund oversight was passed.

As HedgeWorld reported last week:

Much so-called ‘hedge fund fraud,’ he [Atkins] said, was in fact just garden variety fraud using the name ‘hedge fund’ because the scammer’s targets find the term impressive. Registration could deter such a con artist from using that name for his schemes, but would not deter the scheme itself.

Atkins is right. Accusing hedge funds of being nefarious because some crack-pot calls himself a hedge fund is like indicting gun owners - not for the misdeeds of gun-toting criminals - but because someone merely pretended to have a gun. (Or like invading a region because one of its leaders needed some respect and therefore faked having weapons of mass destruction.)

The key lesson being that “it doesn’t matter if you’re making the whole thing up, we’ll pretend you were serious and go after the people you were impersonating.”

Here’s a good example of how the SEC’s new hedge fund anti-fraud rule is being used. According to HedgeWorld:

In April, the SEC sued Jason Hyatt, Jay Johnson and Hyatt Johnson Capital, a privately-held company headquartered in Illinois. The three men misappropriated at least $5.4 million of the investors’ money to pay to operate a Latin-themed restaurant in Chicago and to pay for Hyatt’s personal expenses. The three raised at least $24.5 million from approximately 120 investors in at least 12 states.

This tragic story leaves little doubt about the tough actions required by the SEC: regulate Latin-themed-restaurant-hedge-funds! Do it now - before someone mistakenly eats some of that 6-alarm salsa or suffers some untimely mariachi injury.