Are Hedge Funds Still Private? Exploring Publicness in the Face of Incoherency

Abstract

Academics have frequently noted that the term “public” is one of the most under theorized concepts under our federal securities laws. It has never been sufficiently defined by Congress, and issuers must instead rely on various indicators of publicness gleaned from an extensive patchwork of rules and exemptions. A prevalent indicator of publicness includes the status of investors, where investment companies that broadly offer investments to the general public, such as mutual funds and money-market funds, are required to register under a complex web of federal legislation. Relatedly, private investment companies such as hedge funds and private equity funds, which restrict offerings to elite investors, are typically considered private and are thus exempt from federal regulation. Other historical indicators include advertising, size of pool, and number of investors/clients. However, these historical indicators of publicness did not capture the increasing effect that private funds were having on the general public, such as systemic risk, retailization, and participation in the shadow banking industry. Congress responded by expanding indicators of publicness through the Dodd-Frank Act of 2010, which created new registration requirements for private funds irrespective of the status of such underlying investors.

Nevertheless, this article argues that Congress has improperly focused on ancillary laws, such as the Investment Advisers Act of 1940 and the Commodity Exchange Act of 1936, to integrate evolving notions of publicness in the regulation of investment companies. Congress should instead focus on the Investment Company Act of 1940 (“1940 Act”), which is the primary legislation tailored to the industry. In focusing on these ancillary laws, Congress has effectively expanded and complicated the patchwork of regulation that applies to these entities, which has further complicated the examination of publicness from a theoretical, regulatory, and practical perspective. This improper focus has also resulted in under-inclusive and over-inclusive indicators of publicness under the 1940 Act, further compromising investor protection in these burgeoning markets. An alternative framework should include the following tasks: (1) integrate emerging indicators of publicness under the 1940 Act; (2) conduct a wholesale review of the 1940 Act; and (3) monitor other strategies that could invoke public concerns such as hedge fund activism, third-party litigation funding, and investment in distressed economies such as Detroit, Puerto Rico, and Greece. This article builds on the current literature on this topic which has largely focused on the incoherency of publicness in the context of the Securities Act of 1933 and the Securities Exchange Act of 1934. This article is the first to assess whether emerging notions of publicness have been properly incorporated under the 1940 Act.