State competition for hedge funds

Congress is reportedly considering legislation that would let states regulate investment advisors, including hedge funds, which manage less than $100 million. This would shift some funds from SEC regulation and require state registration of some previously unregulated funds.

Of course we're going to hear about a race to the bottom that boosts systemic risk. But funds do have an incentive to offer assurances to their investors and therefore to "bond" themselves by seeking responsible and expert regulators.

Perhaps surprisingly, one critic of state regulation is Richard Blumenthal, attorney general in the Connecticut, home of many hedge funds.

Current rules in Connecticut and New York have exemptions that many hedge-fund advisers exploit to avoid state oversight. Mr. Blumenthal said that if states are given more powers, Connecticut will likely have to revise its laws for "more-robust oversight and fewer exemptions."

Maybe Blumenthal's reticence isn't too surprising. Connecticut may fear having to enter a competition that could threaten its leadership.

According to the WSJ, critics "also warn that a patchwork of state rules could burden advisers that operate in more than one jurisdiction."

There's a solution to that: let each fund choose the regulating state, just as corporations can choose where to incorporate. Again, the market for hedge fund investments offers some protection against a race to the bottom. And consider the alternative: one size fits all regulation by the agency that gave us Madoff.

Comments

[Bart Mallon]

State regulation is not the answer. With only a handful of exceptions, the state regulatory agencies do not know what they are doing. Additionally, and maybe more importantly, the states do not have the budgets to properly supervise advisors with AUM over $25 million. As the quote above mentions, many states already have exemptions from state registration which will leave a regulatory gap unless the states move forward with additional legislation.