Proposal to Let Hedge Funds Hide Their Holdings Likely Going Down in Flames

In July 2020, the Securities and Exchange Commission made a proposal to vastly change the reporting requirements of hedge funds. The Securities and Exchange Commission’s proposal would permit hedge funds with less than $3.5 billion in assets to stop reporting their holdings in quarterly reports to the Securities and Exchange Commission.  At this time, the Securities and Exchange Commission requires quarterly disclosure of stock positions held by hedge funds that have more than $100 million in assets under management.

According to the Financial Times, during the ‘consultation period’ when the Securities and Exchange Commission considers comments made about their proposed changes, 2.262 letters were submitted to the Securities and Exchange Commission regarding the proposed change to the disclosure rules.  Of these 2,262 comment letters, 99% were against the proposed rule, according to Financial Times. The result of such a large number of letters opposing the rule change is that the Securities and Exchange Commission is expected to withdraw its proposal and keep the current disclosure threshold of $100 million.

The $100 million threshold has been in place since 1975 and it requires hedge funds to file a “13-F” report each quarter to disclose their holdings.  The Securities and Exchange Commission looked at the fact that the US equity market capitalization has grown from $1 trillion to an $35 trillion and decided that it was time to raise the disclosure limit.  The Securities and Exchange commission also claimed that the disclosure requirements at $100 million were a burden to the smaller hedge funds. This reasoning leaves out the impact that its actions would have on the transparency of the markets. The Financial Times reports that hedge fund managers were skeptical of the Securities and Exchange Commission’s reasoning.  The smaller hedge fund managers and even the CFA Institute noted that the costs to file the 13F are negligible and the process was mostly automated by today’s portfolio accounting software programs.

There are plenty of reasons why the proposed rule change is a bad idea that would have long term negative effects on the securities markets.  The financial markets need to be as transparent as possible to protect investors and the integrity of the public securities markets.  Whenever rules create additional options for hedge funds to obscure their investments, the individual investor is at a disadvantage.  The individual investor should have access to understanding the positions taken by hedge funds because it can help guide their own investing and provide clues as to how the ‘experts’ value an investment that an individual investor may want to make.

Financial Times noted that another potential problem with the proposed disclosure threshold increase is that it would permit activist investors to accumulate larger stakes in companies, thus forcing companies to develop new strategies for dealing with activist investors.  An ‘activist investor’ is one who buys shares in a publicly traded company in order to get board of director seats and then work to make significant changes to the target company. This may sometimes be beneficial for the target company but it could also lead to negative impacts by derailing management’s plans to grow the target company and ultimately hurting shareholders of the target company.

The New York Stock Exchange’s letter warned that small and medium size publicly traded companies could be hardest hit, according to Financial Times. Since smaller companies have a smaller ‘float’ of shares, an activist company could quickly purchase a significant portion of the company’s shares and in effect take over the company from its current managers by obtaining multiple board of director seats and thus call the shots.

The outpouring of resistance by hedge funds, publicly traded companies and large pension funds to the Securities and Exchange Commission’s proposed rule change is a welcome sign in a world where many people may believe that Wall Street is trying to take advantage of them.  Let’s hope that the Securities and Exchange Commission does withdraw this rule change proposal.

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