[Congressional Record Volume 155, Number 18 (Thursday, January 29, 2009)]
[Senate]
[Pages S1058-S1061]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]

      By Mr. GRASSLEY (for himself and Mr. Levin):
  S. 344. A bill to require hedge funds to register with the Securities 
and Exchange Commission, and for other purposes; to the Committee on 
Banking, Housing, and Urban Affairs.
  Mr. GRASSLEY. Mr. President, 3 years ago, I started conducting 
oversight of the Securities and Exchange Commission. That oversight 
began in response to a whistleblower who came to my office complaining 
that SEC supervisors were impeding an investigation into a major hedge 
fund.
  Soon afterward, I came to the floor of the Senate to introduce an 
important piece of legislation based on what I learned from that 
oversight. The bill was aimed at closing a loophole in securities law 
that allows hedge funds to operate under the cloak of secrecy. 
Unfortunately, that bill, S. 1402, was never taken up by the Banking 
Committee in the last Congress.
  In light of the current instability in our financial system, I think 
it is very critical for the Senate to deal with this issue and do it in 
the near future. Therefore, I am pleased Senator Levin, who is on the 
floor, and I worked together to produce an even better version of the 
bill than I introduced previously, and we are now doing that in the 
111th Congress.
  I thank Senator Levin because he is on a very important oversight 
committee as well and does a lot of oversight, as I do. I appreciate 
everything he does in maybe a lot of different areas than I do, but I 
appreciate working together with him on this issue.
  This new bill, the Hedge Fund Transparency Act, does everything the 
previous version did, but it does more and does it better.

[[Page S1059]]

  As in the previous version, it clarifies current law to remove any 
doubt that the Securities and Exchange Commission has the authority to 
require hedge funds to register--simply to register--so the Government 
knows who they are and what they are doing. It removes the loophole 
previously used by hedge funds to escape the definition of an 
``investment company'' under the Investment Company Act of 1940.
  Under this legislation, hedge funds that want to avoid the stringent 
requirements of the Investment Company Act will only be exempt if, one, 
they file basic disclosure forms; and two, cooperate with requests for 
information from the Securities and Exchange Commission.
  I thank Senator Levin for not only cosponsoring this legislation but 
also contributing a key addition to this new version of the bill. In 
addition to requiring basic disclosure, this version also makes it 
clear that the hedge funds have the same obligations under our money 
laundering statutes as other financial institutions. They must report 
suspicious transactions and establish anti-money laundering programs.
  One major cause of the current crisis is a lack of transparency. 
Markets need a free flow of reliable information to function properly. 
Transparency was the focus of our system of securities regulations 
adopted way back in the 1930s. Unfortunately, over time, the wizards on 
Wall Street figured out a million clever ways to avoid transparency. 
The result is the confusion and uncertainty fueling the crisis today 
that we see.
  This bill is an important step toward renewing commitment to 
transparency on Wall Street and establishing credibility in our 
financial sector among the American populace. Unfortunately, there was 
not much of an appetite for this sort of commonsense legislation when I 
first introduced it before the financial crisis erupted. Hopefully, 
attitudes have changed, given all that has happened since the collapse 
of Bear Stearns last March. It is all very obvious to us, and 
particularly connected with the credit crunch and with the recession.
  Hedge funds are pooled investment companies that manage billions of 
dollars for groups of wealthy investors, and do it in total secrecy. 
Hedge funds affect regular investors. They affect the market as a 
whole. My oversight of the SEC convinces me that the Commission needs 
much more information about the activities of hedge funds in order to 
protect the markets. Any group of organizations that can wield hundreds 
of billions of dollars in market power every day should be transparent 
and disclose basic information about their operations to the agency 
that Americans rely on as the watchdogs of our Nation's financial 
markets.
  As I explained when I first introduced this bill, the Securities and 
Exchange Commission already attempted to oversee the hedge fund 
industry by regulation. Congress needs to act now because of a decision 
of a Federal appeals court. In 2006, the DC Circuit Court of Appeals 
overturned an SEC administrative rule requiring the registration of 
hedge funds. That decision effectively ended all registration of hedge 
funds with the Securities and Exchange Commission, unless and until we 
in Congress take action.
  The Hedge Fund Transparency Act would respond to that court decision 
by, one, including hedge funds in the definition of investment company; 
and two, bringing much needed transparency to this supersecretive 
industry. The Hedge Fund Transparency Act is a first step in ensuring 
that the Securities and Exchange Commission has clear authority to do 
what it has already tried to do. Congress must act to ensure that our 
laws are kept up to date as new types of investments appear.
  Unfortunately, this legislation hasn't had many friends. These funds 
don't want people to know what they do or who participates in them. 
They have fought hard to keep it that way. Well, I think that is all 
the more reason to shed some light--particularly some sunlight--on them 
to see what they are doing.
  So I urge my colleagues to cosponsor and support this legislation, to 
support Senator Levin of Michigan and me in this effort as we work to 
protect all taxpayers, large and small.
  Once again I thank Senator Levin. And before I yield the floor, Mr. 
President, I ask unanimous consent to have printed in the Record a 
background paper on the Hedge Fund Transparency Act.
  There being no objection, the material was ordered to be printed in 
the Record, as follows:

                      Hedge Fund Transparency Act

       Background: This bill is a revised version of S. 1402, 
     which Sen. Grassley introduced in the 110th Congress. While 
     the previous bill amended the Investment Advisers Act of 
     1940, this bill amends the Investment Company Act of 1940 
     (``ICA''). However, the purpose is the same: to make it clear 
     that the Securities and Exchange Commission has the authority 
     to require hedge fund registration. This version also adds a 
     provision authored by Sen. Levin to require hedge funds to 
     establish anti-money laundering programs and report 
     suspicious transactions.


                  hedge fund registration requirements

       Definition of an Investment Company: Hedge Funds typically 
     avoid regulatory requirements by claiming the exceptions to 
     the definition of an investment company contained in 
     Sec. 3(c)(1) or Sec. 3(c)(7) of the ICA. This bill would 
     remove those exceptions to the definition, transforming them 
     to exemptions by moving the provisions, without substantive 
     change, to new sections Sec. 6(a)(6) and Sec. 6(a)(7) of the 
     ICA.
       Requirements for Exemptions: An investment company that 
     satisfies either Sec. 6(a)(6) or Sec. 6(a)(7) will be 
     exempted from the normal registration and filing requirements 
     of the ICA. Instead, a company that meets the criteria in 
     Sec. 6(a)(6) or Sec. 6(a)(7) but has assets under management 
     of $50,000,000 or more, must meet several requirements in 
     order to maintain its exemption. These requirements include:
       1. Registering with the SEC.
       2. Maintaining books and records that the SEC may require.
       3. Cooperating with any request by the SEC for information 
     or examination.
       4. Filing an information form with the SEC electronically, 
     at least once a year. This form must be made freely available 
     to the public in an electronic, searchable format. The form 
     must include:
       a. The name and current address of each individual who is a 
     beneficial owner of the investment company.
       b. The name and current address of any company with an 
     ownership interest in the investment company.
       c. An explanation of the structure of ownership interests 
     in the investment company.
       d. Information on any affiliation with another financial 
     institution.
       e. The name and current address of the investment company's 
     primary accountant and primary broker.
       f. A statement of any minimum investment commitment 
     required of a limited partner, member, or investor.
       g. The total number of any limited partners, members, or 
     other investors.
       h. The current value of the assets of the company and the 
     assets under management by the company.
       Timeframe and Rulemaking Authority: The SEC must issue 
     forms and guidance to carry out this Act within 180 days 
     after its enactment. The SEC also has the authority to make a 
     rule to carry out this Act.
       Anti-Money Laundering Obligations: An investment company 
     exempt under Sec. 6(a)(6) or Sec. 6(a)(7) must establish an 
     anti-money laundering program and report suspicious 
     transactions under 31 U.S.C.A 5318(g) and (h). The Treasury 
     Secretary must establish a rule within 180 days of the 
     enactment of the Act setting forth minimum requirements for 
     the anti-money laundering programs. The rule must require 
     exempted investment companies to ``use risk-based due 
     diligence policies, procedures, and controls that are 
     reasonably designed to ascertain the identity of and evaluate 
     any foreign person that supplies funds or plans to supply 
     funds to be invested with the advice or assistance of such 
     investment company.'' The rule must also require exempted 
     investment companies to comply with the same requirements as 
     other financial institutions for producing records requested 
     by a federal regulator under 31 U.S.C. 5318(k)(2).

  Mr. LEVIN. Mr. President, history has proven time and time again that 
the markets are not self-policing. Today's financial crisis is due in 
part to the Government's failure to regulate key market participants, 
including hedge funds that have become unregulated financial 
heavyweights in the U.S. economy. So I am joining today with my 
colleague Senator Grassley of Iowa to introduce the Hedge Fund 
Transparency Act, and I thank Senator Grassley for his leadership on 
this and in so many other areas involving oversight of our financial 
institutions.
  Hedge funds sound complicated, but they are simply private investment 
funds in which investors have agreed to pool their money under the 
control of an investment manager. What distinguishes them from other 
investment funds is that hedge funds are typically open only to 
``qualified purchasers,'' an SEC term referring to institutional 
investors such as pension funds and wealthy individuals with assets 
over a

[[Page S1060]]

specified minimum amount. In addition, most hedge funds have 100 or 
fewer beneficial owners. By limiting the number of their beneficial 
owners and accepting funds only from investors of means, hedge funds 
have been able to qualify for the statutory exclusions provided in the 
Investment Company Act and avoid the obligation to comply with that 
law's statutory and regulatory requirements. In short, hedge funds have 
been able to operate outside of the reach of the Securities and 
Exchange Commission.
  The primary argument for allowing these funds to operate outside SEC 
regulation and oversight is that because their investors are generally 
more experienced than the general public, they need fewer government 
protections and their investment funds should be permitted to take 
greater risks than investment funds open to the investing public which 
need greater SEC protection. Indeed, the ability of hedge funds to take 
on more risk is the very reason that many individuals and institutions 
choose to invest in them. These investors accept more risk because that 
might lead to bigger rewards.
  The compensation system employed by most hedge funds encourages that 
risk taking. Typically, investors agree to pay hedge fund investment 
managers a management fee of 2 percent of the fund's total assets, plus 
20 percent of the fund's profits. The hedge fund managers profit 
enormously if a fund does well, but due to the guaranteed management 
fee, get a hefty payment even when the fund underperforms or fails. The 
analysis up to now has been that if wealthy people want to take big 
risks with their money, all else being equal, they should be allowed to 
do so without the safeguards normally required for the general public.
  So what is the problem with allowing their investment funds to 
operate outside of Federal regulation and oversight? The problem is 
that hedge funds have gotten so big and are so entrenched in U.S. 
financial markets that their actions can now significantly impact 
market prices, damage other market participants, and can even endanger 
the U.S. financial system and the economy as a whole.
  The systemic risks posed by hedge funds first became obvious 10 years 
ago. Back then, Long-Term Capital Management--or LTCM--was a hedge fund 
that, at its peak, had more than $125 billion in assets under 
management and, due to massive borrowing, a total market position of 
$1.3 trillion. When it began to falter, the Federal Reserve worried 
that it might unload its assets in a rush, drive down prices, and end 
up damaging not only other firms but U.S. markets as a whole. To 
prevent a financial meltdown, the Federal Reserve worked with the 
private sector to engineer a rescue package.
  That was just over a decade ago. Since then, according to a recent 
report issued by the Congressional Research Service, the hedge fund 
industry has expanded roughly tenfold. In 2006, the SEC testified that 
hedge funds represented 5 percent of all U.S. assets under management 
and 30 percent of all equity trading volume in the United States. By 
2007, an estimated 8,000 hedge funds were managing assets totaling 
roughly $1.5 trillion. The most current estimate is that 10,000 hedge 
funds are managing approximately $1.8 trillion in assets, after 
suffering losses over the last year of over $1 trillion.
  In addition, over the last 10 years, billions of dollars being 
managed by hedge funds have been provided by pension plans. A 2007 
report by the U.S. Government Accountability Office found that the 
amount of money that defined benefit pension plans have invested in 
hedge funds has risen from about $3.2 billion in 2000 to more than $50 
billion in the year 2006. That total is probably much higher now. And 
while most individual pension funds invest only a small slice of their 
money in hedge funds, a few go farther. For example, according to the 
GAO report, as of September 2006, the Missouri State Employees 
Retirement System had invested over 30 percent of its assets in hedge 
funds. Universities and charities have also directed significant assets 
to hedge funds. The result is that hedge fund losses threaten every 
economic sector in America, from the wealthy to the working class 
relying on pensions, to our institutions of higher learning, to our 
nonprofit charities.
  A third key developed is that over the last 10 years, some of the 
largest U.S. banks and security firms have set up their own hedge funds 
and used them to invest not only client funds but also their own cash. 
In some cases, these hedge funds have commingled client and 
institutional funds and linked the fate of both to high-risk investment 
strategies. These hedge fund affiliates are typically owned by the same 
holding companies that own federally insured banks or federally 
regulated broker-dealers. Because of their ownership, their size and 
reach, their clientele, and the high-risk nature of their investments, 
the failure of hedge funds today can imperil not only their direct 
investors, but also the financial institutions that own them, that lent 
them money, or did business with them. From there, the effects can 
ripple through the markets and impact the entire economy.
  It is time for Congress to step into the breach and establish clear 
authority for Federal regulation and oversight of hedge funds. That is 
the backdrop for the introduction of the Grassley-Levin Hedge Fund 
Transparency Act.
  The purpose of this bill is to institute a reasonable and practical 
regulatory regime for hedge funds. The bill contains four basic 
requirements to make hedge funds subject to SEC regulation and 
oversight.
  It requires them to register with the SEC, to file an annual 
disclosure form with basic information that will be made publicly 
available, to maintain books and records required by the SEC, and to 
cooperate with any SEC information request or examination.
  In addition, the bill directs Treasury to issue a final rule 
requiring hedge funds to establish anti-money laundering programs and, 
in particular, to guard against allowing suspect offshore funds into 
the U.S. financial system. The Bush Administration issued a proposed 
anti-money laundering rule for hedge funds seven years ago, in 2002, 
but never finalized it. A 2006 investigation by the Permanent 
Subcommittee on Investigations, which I chair, showed how two hedge 
funds brought millions of dollars in suspect funds into the United 
States, without any U.S. controls or reporting obligations, and called 
on a bipartisan basis for the proposed hedge fund anti-money laundering 
regulations to be finalized, but no action was taken. Hedge funds are 
the last major U.S. financial players without anti-money laundering 
obligations, and it is time for this unacceptable regulatory gap to be 
eliminated.
  Our bill imposes a set of basic disclosure obligations on hedge funds 
and makes it clear they are subject to full SEC oversight while, at the 
same time, exempting them from many of the obligations that the 
Investment Company Act imposes on other types of investment companies, 
such as mutual funds that are open for investment by all members of the 
public. The bill imposes a more limited set of obligations on hedge 
funds in recognition of the fact that hedge funds do not open their 
doors to all members of the public, but limit themselves to investors 
of means. The bill also, however, gives the SEC the authority it needs 
to impose additional regulatory obligations and exercise the level of 
oversight it sees fit over hedge funds to protect investors, other 
financial institutions, and the U.S. financial system as a whole.
  The bill imposes these requirements on all entities that rely on 
Sections 80a-3(c)(1) or (7) to avoid compliance with the full set of 
the Investment Company Act requirements. A wide variety of entities 
invoke those sections to avoid those requirements and SEC oversight, 
and they refer to themselves by a wide variety of terms--hedge funds, 
private equity funds, venture capitalists, small investment banks, and 
so forth. Rather than attempt a futile exercise of trying to define the 
specific set of companies covered by the bill and thereby invite future 
claims by parties that they are outside the definitions and thus 
outside the SEC's authority, the bill applies to any investment company 
that has at least $50 million in assets or assets under its management 
and relies on Sections 80a-3(1) or (7) to avoid compliance with the 
full set of Investment Company Act requirements. Instead, those 
companies under the bill have to comply with a reduced set of 
obligations, which include filing an annual public disclosure

[[Page S1061]]

form, maintaining books and records specified by the SEC, and 
cooperating with any SEC information request or examination.
  Finally, our bill makes an important technical change. It moves 
paragraphs (c)(1) and (7)--the two paragraphs that hedge companies use 
to avoid complying with the full set of Investment Act Company 
requirements--from Section 80a-3 to Section 80a-6 of the Investment 
Company Act. While our bill preserves both paragraphs and makes no 
substantive changes to them, it moves them from the part of the bill 
that defines ``investment company'' to the part of the bill that 
exempts certain investment companies from the Investment Company Act's 
full set of requirements.
  The bill makes this technical change to make it clear that hedge 
funds really are investment companies, and they are not excluded from 
the coverage of the Investment Company Act. Instead, they are being 
given an exemption from many of that law's requirements, because they 
are investment companies which voluntarily limited themselves to one 
hundred or fewer beneficial owner accepting funds only from investors 
of means. Under current law, the two paragraphs allow hedge funds to 
claim they are excluded from the Investment Company Act--they are not 
investment companies at all and are outside the SEC's reach. Under our 
bill, the hedge funds would qualify as investment companies--which they 
plainly are--but would qualify for exemptions from many of the Act's 
requirements by meeting certain criteria.
  It is time to bring hedge funds under the federal regulatory 
umbrella. With their massive investments, entanglements with U.S. 
banks, securities firms, pension funds, and other large investors, and 
their potential impact on market equilibrium, we cannot afford to allow 
these financial heavyweights to continue to operate free of government 
regulation and oversight.
  When asked at a recent hearing of the Senate Homeland Security and 
Government Affairs Committee whether hedge funds should be regulated, 
two expert witnesses gave the exact same one-word answer: ``Yes.'' One 
law professor, after noting that disclosure requirements don't apply to 
hedge funds, told the Committee: ``If you asked a regulator what . . . 
role did hedge funds play in the current financial crisis, I think they 
would look at you like a deer in the headlights, because we just don't 
know.'' It is essential that federal financial regulators know what 
hedge funds are doing and that they have the authority to prevent 
missteps and misconduct.
  The Hedge Fund Transparency Act will protect investors, and it will 
help protect our financial system. I hope our colleagues will join us 
in support of this bill and its inclusion in the regulatory reform 
efforts that Congress will be undertaking later this year.
                                 ______