Federalism and hedge funds

From Dealbreaker comes links to reports about how Connecticut is dealing with the difficult balancing act of catering to interest groups that want to regulate hedge funds without actually scaring those bags of money away. The CT legislature is weighing Republican and Democratic proposals that will come out on either side of this delicate dividing line. Of course CT’s AG Blumenthal, envious that Spitzer is governor and he’s not (yet), doesn’t want to oppose the regulation, but at the same time doesn’t want to scare the hedge funds out of his state. So he’s calling for federal regulation.

My paper, Corporations and the Market for Law, deals with the political equilibrium here. Delaware doesn’t have these conflicts when it comes to corporate law because they don’t have all these messy interest groups. So Delaware straight out competes. Other states have interest groups that want to regulate internal corporate governance, but they don’t want to give corporations incentives to avoid their borders. Hence the pressure to regulate corporate governance under federal law.

State competition outside the area of publicly held corporations is even more instructive for the hedge fund scenario. Consider statutory business trusts, which house mutual funds. Massachusetts and Connecticut compete with Delaware for this business. They don't have to worry about appeasing the pro-regulatory interest groups, because mutual funds are already heavily regulated by federal investment company law. Not surprisingly, we’re seeing pressure to extend the full force of that law to hedge funds.