IT ISN’T THE purview of government to keep me from smoking cigarettes or eating fattening foods. Nor is it the responsibility of government to give me a job, an education or health care. While I’m confident that things could be “better” in this country, it can’t (and shouldn’t) be government controls that make it so.
Our society is founded on the principles of a government of laws, not of men. And although we’ve come to expect elected officials to push their agendas, the truth is that America isn’t clay to be molded by whoever is in office at the time. The Constitution is a document that limits the power of government. We all want the world to be a happier place, but the reality is that the government’s responsibility is rather narrow: to protect individual rights.
Yet over the decades, the role of government has gradually been shifted from protecting our rights to defining them. The law has now become the product of institutionalized mob rule. And because we’ve allowed some individual rights to be compromised, now they’re all up for grabs. Most people have come to expect that the government can do whatever it wants.
A prime example can be found in the way hedge funds are treated in this country. We last wrote about hedge funds a few years back. In recent weeks, the Securities and Exchange Commission has begun an investigation that’s almost sure to end in new regulatory constraints. And although as Americans our liberties aren’t to be limited by the government, but protected under them, even the existing hedge-fund regulation demonstrates how easily rights can be compromised by the whims of nonelected regulators who claim to serve the “public good.”
There exists a complete ignorance about what hedge funds really are — even among the regulators who oversee them. A hedge fund is simply a business in which a general partner invests on behalf of individual or institutional investors. To that end, hedge funds must file all appropriate tax documentation, as well as register in each state in which they wish to do business.
Although they have the ability to utilize any number of strategies, hedge funds don’t necessarily sell short, or use leverage, or engage in high-turnover trading strategies. Truth be told, many simply buy stocks or bonds, and are less risky than plain-vanilla mutual funds.
What separates hedge funds from, say, mutual funds, is that they aren’t required to register with the SEC, a costly and time-intensive process that requires expensive legal representation and a whole lot of paperwork.
But just because hedge funds don’t register with the SEC doesn’t mean they (or their operators) are exempt from the rule of law. Money invested in hedge funds can’t be used to hire assassins or traffic in illegal arms. Hedge-fund managers don’t have the right to steal clients’ money or otherwise break the terms of a fund’s operating agreement. So in the most basic sense, hedge funds are regulated like any other individual or business is — by objective laws designed to protect individual rights.
Moreover, to suggest that hedge funds are “unregulated” isn’t just ignorance but farce. Hedge funds are already extremely regulated, and in many ways, unconstitutionally so.
For example, the reason why hedge funds are so secretive is that the government requires them to be. Unlike beer companies, cigarette makers or pornography peddlers, hedge funds aren’t permitted to advertise — or for that matter publicly solicit in any fashion. Think about it: In the eyes of regulators, hedge funds are so dangerous and potentially harmful to the public that it justifies eliminating the basic First Amendment rights of their operators to promote their product. Is there any other product or industry that’s subject to the same draconian constraints?
And naturally, because hedge funds aren’t permitted to promote themselves, the only time one ends up hearing about them is on the infrequent occasion when something goes wrong. The truth is, despite the SEC hysteria about (gasp!) unregistered pools of investment capital, the vast majority of funds are honest, ethical and serve an important function to both their investors and the public at large.
But because funds are forbidden from being public, most of the public doesn’t know the first thing about them. In fact, as we’ve pointed out before, they’ve become the market’s perennial scapegoat: Dow down? Must be the hedge funds. XYZ plummets? Must be the hedge funds.
The reason hedge funds cater to the wealthy is because government regulations require them to. Current, albeit antiquated, rules forbid hedge funds from accepting investments from “unaccredited” investors — that’s regulatory-speak for the rich. So unless you’ve got a liquid net worth of greater than $1 million, or have made more than $200,000 for two years running, the government forbids you from making hedge funds part of your investment portfolio. And while regulators consider themselves to be champions protecting the public good, the restrictions are short-sighted, uninformed and an obvious infringement on the property rights of individuals, rich and not rich alike.
The net-worth requirements fail to account for the fact that, as we noted before, hedge funds aren’t inherently riskier then their registered counterparts. In fact, the real loss of capital over the past few years hasn’t come from hedge funds (which have outperformed the market), but from SEC-regulated investments. Think about how many trillions of dollars have been squandered thanks to the recommendations, trading and money-management skills of SEC-regulated mutual funds and investment advisers?
Moreover, by forbidding less-affluent individuals to invest even a portion of their assets in hedge funds, the vast majority of investors are legally unable to take advantage of strategies and techniques that, over the past few years, have made money. How that reality is considered “protecting the public good” I’ll never understand.
The most disturbing element of hedge-fund regulation, however, is that it violates an individual’s property rights to invest as he or she sees fit. You see, hedge funds, just like restaurants and office buildings, are private property, and therefore aren’t subject to public controls. As noted before, a hedge fund is simply a pool of investment capital. And by limiting who may invest, even in the name of the public good, the government is infringing on property rights of individuals to do with their assets as they please. Is that what’s considered a free market?
In the final analysis, the real issue here isn’t even hedge funds, but the way in which we now permit government to regulate our business and private property. It’s bad enough that most people have come to believe that any business that isn’t directly regulated by the government is unsafe, potentially criminal and a danger to the public. Even worse, however, is that most business owners have thrown up their hands and accepted the fact that their private enterprise is the domain of public control. It is not.
– Originally on May 19, 2003 by Jonathan Hoenig
