Rethinking U.S. Investment Adviser Regulation

Although the U.S. Investment Advisers Act of 1940 (the “Advisers Act”) was not at the center of the post-financial crisis regulatory reform that culminated in the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank” or “Dodd-Frank Act”), it was certainly part of the reform effort. In particular, Dodd-Frank amended the Advisers Act--the federal statute that regulates investment advisers and their activities--in a manner intended to address the ways in which privately-offered funds, particularly hedge funds, may have exacerbated the financial crisis. The primary regulatory concern, whether valid or not, was that, given the magnitude of assets invested in hedge funds and hedge funds\u27 penchant for pursuing certain types of risky investment activities, such as taking positions in credit default swaps, those funds potentially helped create systemic risk. Arguably, Dodd-Frank was about nothing if not mitigating systemic risk. And so lawmakers set about to bolster “hedge fund regulation.” They did so, ultimately, by effectively stapling various hedge fund-related provisions to the Advisers Act, notwithstanding that that statute theretofore contained nary a mention of hedge funds. In broad strokes, as a result of Dodd-Frank\u27s amendments and the Securities and Exchange Commission\u27s (the “SEC”) rulemaking under Dodd-Frank, investment advisers who manage hedge funds are required to become registered with, and regulated by, either the SEC or the relevant state regulatory authorities. That result is, in large part, a product of Dodd-Frank\u27s elimination of an exemption from SEC registration on which, prior to Dodd-Frank, many advisers to hedge funds had relied. In addition, most advisers managing enough assets to be required to register with the SEC are now required to submit to the SEC periodic reports containing a wide range of information about the funds they manage, including those funds\u27 investment activities and portfolio holdings. The SEC, furthermore, is authorized to share that information with the newly-created Financial Services Oversight Council. Now, in the aftermath of Dodd-Frank\u27s enactment and the SEC\u27s associated bout of rulemaking, one might think that the Advisers Act\u27s regulatory regime is a workable and effective one, equipped to address--and address efficiently--the investor-protection risks that the twenty-first-century investment adviser industry produces. In fact, however, Dodd-Frank did not touch--and, indeed, Dodd-Frank\u27s crafters indicated no awareness of--many of the Advisers Act\u27s longstanding troubles. Additionally, the changes Dodd-Frank brought about have their own considerable deficiencies. As this Article contends, the U.S. investment adviser regulatory regime, now seventy-four years old, is in need of more than a few statutory amendments and new SEC rules. For the sake of the investor-protection goals of securities regulation, the promotion of market integrity, and regulatory efficiency, U.S. investment adviser regulation needs to be rethought and reformed. Focusing both on longstanding and new regulatory weaknesses, this Article highlights five grounds for that conclusion: regulation exemptions, hedge funds and other private funds, advisers to publicly-offered funds, specific rules versus broad standards, and examination and enforcement