Edhec-Risk
Alternative Investments - January 14, 2008

Interview with US SEC Commissioner Paul S. Atkins

In this month's interview1, we speak to US SEC Commissioner Paul S. Atkins, who was a keynote speaker at EDHEC's recent Hedge Fund Roundtable of Global Thought Leaders presented in partnership with CNBC Europe and the International Herald Tribune as part of the EDHEC Alternative Investment Days. Having spoken at the roundtable on the subject of regulation risk and whether regulators' attempts to protect investors were increasing moral hazard and adverse selection, Commissioner Atkins here addresses issues ranging from the implications of the growth of the hedge fund industry to shareholder activism and the subprime crisis.


US SEC Commissioner Paul S. Atkins

In September 2003, the SEC released a staff report on the implications of the growth of the hedge fund industry. Since then, of course, that industry has grown considerably larger and the SEC had taken a certain number of initiatives to control hedge fund activities and risks. How do you assess those initiatives today and what do you think are the current implications of hedge fund growth?

Paul Atkins: In the wake of the 2003 staff report, the SEC’s first hedge fund initiative was a mandatory registration requirement for advisors to hedge funds. The stated justifications for the rule included retailization, a purported wave of hedge fund fraud, and a lack of information. The staff report found that retailization was not occurring. The rule would have done nothing to prevent the vast majority of the frauds that were cited in connection with the rule. As to the lack of information about hedge funds, the SEC should have consulted with other federal agencies that collect data about hedge funds before adopting the rule. In fact, the Federal Reserve, the Treasury Department, and the Commodity Futures Trading Commission (“CFTC”) expressed their objections to our rule.

Ultimately, the rule was rejected by a court because it was outside the scope of our authority. The rule nevertheless has had lasting effects. Many advisors who had registered in response to the rule decided to remain registered for business reasons. Unfortunately for investors, I suspect that many advisors who avoided registration by extending their lock-up periods (which is the metric that the rule used to identify hedge funds) have retained those longer lock-up periods.

The experience did reinforce valuable principles for regulating hedge funds. In deciding what sorts of constraints to place on the activities of hedge funds, we must not lose sight of the important role that hedge funds play in providing liquidity in the markets and diversifying their investors’ portfolios. We also must take care not to assume that restrictions placed on hedge funds will stop garden-variety fraud - common criminals labelling their scam a “hedge fund.” We must remember, too, that SEC resources devoted to inspecting hedge fund advisors are resources that cannot be spent on inspecting advisors to mutual funds, to whom the vast majority of investors entrust their savings. After all, hedge funds in the United States cater to institutions and high net worth individuals who either are sophisticated or can hire someone who is. Again, this is what our 2003 staff study found.

I am confident in predicting that the hedge fund sector will continue to flourish. As with any vital sector of the market, we will work with our counterparts in government to keep apprised of hedge funds’ activities. Further, we will unreservedly hold hedge funds to the same legal standards for conduct in the marketplace to which other market participants are held. It is important to note, however, that the SEC can do little to control hedge fund risks, nor is it our role to do so. The SEC does not issue a seal of approval for hedge funds, so it is incumbent upon investors to demand information about the fund both before and after investing.

The SEC's hedge fund registration rule was struck down by a US court last year. What were the implications of this ruling, and how does the SEC see its role in controlling hedge funds today?

Paul Atkins: Because I dissented from the adoption of the rule, I viewed the court’s decision as an opportunity to take a fresh look at the issue of hedge fund regulation. What exactly were we trying to achieve through the registration mandate, and are there other ways to achieve those goals? The SEC chairman who had presided over the adoption of the rule was no longer at the SEC when the rule was overturned by the court. Our current Chairman, Christopher Cox, rather than seeking to rework a registration requirement, devised a more tailored approach to identifying and addressing concerns about hedge funds. We adopted an antifraud rule to make it clear that advisors to hedge funds (and other pooled investment vehicles) cannot defraud the investors in their funds. Basically, if there ever had been any doubt, “thou shalt not rip off thy limiteds.” The SEC also proposed to raise the accreditation standards for investing in hedge funds. The standards, which were set more than 25 years ago, have not been updated for inflation. As drafted, however, the proposal would have done significantly more than just adjust for inflation. Many commenters objected vociferously, so we are currently considering how to proceed.

In the meantime, the Chairman also has been an active participant in the important work of the President’s Working Group (“PWG”), which is composed of the Treasury Secretary and the chairmen of the Federal Reserve Board, the SEC, and the CFTC. Last February, the PWG put out a policy statement regarding private pools of capital that supported a market-based approach with government regulation as the exception2. The Statement discussed the respective roles of hedge fund advisors, counterparties, creditors, regulators, and investors. It is not the intent of the policy statement to deputize investors, creditors, and counterparties to police hedge funds, but rather to recognize that they have a self-interest in monitoring hedge funds and perhaps placing constraints on the hedge funds’ activities. This is the market at work. As the Policy Statement noted, "market discipline of risk-taking is the rule and government regulation is the exception."3 This PWG Statement is consistent with the PWG’s earlier recommended approach in 1999 in the wake of the Long Term Capital Management failure.

There is a lot of talk about hedge funds as shareholder activists, which is often viewed in a negative light, especially in Europe, even though academic studies indicate that it can improve corporate governance and prevent strategic errors. What is your opinion on this? Moreover, the SEC has wished to take decisions to prevent insider trading related to hedge fund activism in US corporations. What are the limits to the SEC's scope for intervention in this area?

Paul Atkins: Shareholder activists can play a valuable role in corporate governance, but one must be cognizant that certain shareholders may be championing corporate actions that are in their own best interest, and not the best interest of the corporation. After all, a shareholder generally does not owe any fiduciary duty to its fellow shareholders. Hedge funds and other shareholder activists may have created a negative impression by pursuing their own self-serving agenda at times.

This problem may be exacerbated by “empty voting” and similar practices that are based on decoupling voting rights from economic interests. This is why good disclosure is so important in this area. Regulatory efforts seek to ensure that shareholders can effectively exercise their state corporate franchise rights.

In the United States, corporate governance issues are generally governed by state law. The SEC’s role is limited. In our latest foray into the area, last year we amended our proxy rules in order to make clarifications necessitated by a recent court decision. The amendments should help to protect shareholders’ right to receive adequate disclosure and antifraud protection in contests for corporate control.

As to insider trading, the SEC, in conjunction with the exchanges, actively monitors the markets and enforces our laws regarding trading on material non-public information. Hedge funds are treated just like any other market participant.

In Europe, notably in France and Germany, numerous voices have been raised to demand increased regulation of hedge funds, whereas you indicated in a recent interview in US News & World Report that there were already many rules covering hedge funds and that regulator intervention could and would occur if necessary. What do you think accounts for the differences in viewpoints between Europe and the US?

Paul Atkins: First, as I always like to remind people, my views are not necessarily those of the US Securities and Exchange Commission or of my fellow commissioners. So there are differences of viewpoint within the US as well as between Europe and the US. That said, on both continents, there is an understandable interest in the hedge fund sector. On both sides of the Atlantic, the industry is beginning to embrace self-regulation through, for example, the development of model codes of conduct. These efforts should help to address the concerns underlying calls for greater regulatory intervention. European and American regulators can and should learn from one another’s regulatory approaches, and, as the increasing internationalization of the hedge fund industry demands, we will have to work to coordinate our regulatory efforts.

In the U.S., hedge funds and their advisors are regulated in a number of important ways. As a threshold matter, because of regulatory constraints, hedge funds in the United States are not marketed to retail investors. The fact that investors in hedge funds are generally highly sophisticated individuals or institutions colors our approach to further regulation. Of course, our antifraud rules apply to hedge funds as to other investment vehicles. Last year, we adopted a new rule to fill in a perceived hole in the antifraud regime. With this broad antifraud authority and our ability to conduct for-cause examinations, we can effectively respond to tips from insiders, investors or counterparties.

Do you think that hedge funds can be considered to be at the origin of the subprime crisis, or do you think that they are rather victims of the crisis?

Paul Atkins: Although we and our counterparts in government are monitoring and looking into the origins of the events of the last year, it does not seem that hedge funds were the origin of the subprime problems. Certainly, hedge funds, along with many other market participants, have been hit quite hard by the problems in the subprime market. To the extent that hedge funds did lose money or even had to shut down, it is a reminder that hedge funds are only appropriate for investors who are sophisticated enough to assess the risks (or can hire someone to help them make that assessment) and are able to bear losses should they occur. We have also had a valuable reminder of the importance of robust valuation procedures, which can be of particular importance at hedge funds. Most importantly, however, we must remember that hedge funds are likely to be an important part of the solution to the subprime crisis.



Footnotes

1 The views that are expressed herein do not necessarily reflect those of the US Securities and Exchange Commission or of Commissioner Atkins’s fellow commissioners.

2 Agreement among PWG and Agency Principals on Principles and Guidelines Related to Private Pools of Capital (Feb. 22, 2007) (available at: http://www.treasury.gov/press/releases/reports/hp272_principles.pdf).

3 Id. at 1 (quoting from 1999 PWG Statement).



About Paul S. Atkins

Paul S. Atkins was appointed by President George W. Bush to be a commissioner of the Securities and Exchange Commission on July 29, 2002. His term expires in 2008.

Commissioner Atkins’ 22-year career has focused on the financial services industry and securities regulation. Before his appointment as commissioner, he assisted financial services firms in improving their compliance with SEC regulations and worked with law enforcement agencies to investigate and rectify situations where investors had been harmed. The largest of these investigations involved the Bennett Funding Group, Inc., a $1 billion leasing company that perpetrated the largest "Ponzi" fraud in U.S. history, in which more than 20,000 investors lost much of their investment. Assisting the company’s court-appointed bankruptcy trustee, he served as crisis president of Bennett’s sole surviving subsidiary. By stabilizing its finances and operations and rebuilding and expanding its business, Commissioner Atkins improved its share value for the remaining investors by almost 2000%.

From 1990-94, Commissioner Atkins served on the staff of two former chairmen of the SEC, Richard C. Breeden and Arthur Levitt, ultimately as executive assistant and counsellor, respectively. Under Chairman Breeden, he assisted in efforts to improve regulations regarding corporate governance, enhance shareholder communications, strengthen management accountability through proxy reform, and decrease barriers to entry for small businesses and middle market companies to the capital markets. Under Chairman Levitt, he was responsible for organizing the SEC's individual investor program, including the first investor town hall meetings, an SEC consumer affairs advisory committee, and other investor education efforts, including the original Invest Wisely brochures regarding the fundamentals of the retail brokerage relationship and mutual fund investment.

Commissioner Atkins began his career as a lawyer in New York City, focusing on a wide range of corporate transactions for U.S. and foreign clients, including public and private securities offerings and mergers and acquisitions. He was resident for 2½ years in his firm's Paris office and admitted as conseil juridique in France in 1988.

A member of the New York and Florida bars, Commissioner Atkins received his J.D. from Vanderbilt University School of Law in 1983 and was Senior Student Writing Editor of the Vanderbilt Law Review. He received his A.B. from Wofford College in 1980 and was a member of Phi Beta Kappa. Originally from Lillington, North Carolina, Commissioner Atkins grew up in Tampa, Florida. He is married with three sons, aged 14, 11 and 7.


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