Regulate public alternatives firms as funds, panelists say

WASHINGTON — The Blackstone Group LP, the New York private-equity firm that underwent one of the largest initial public offerings in history last month, should be regulated as a mutual fund.

WASHINGTON — The Blackstone Group LP, the New York
private-equity firm that underwent one of the largest initial public offerings in history last month, should be regulated as a mutual fund.
That was the conclusion of the majority of a panel of academics and securities experts who testified last Wednesday before the House Oversight and Government Reform subcommittee on domestic policy. The topic was whether small investors should be exposed to the risks of private-equity and hedge funds.
“When private speculators turn to the public markets for capital … they cannot continue to operate as if they were still a private concern,” said Joseph Borg, president of the North American Securities Administrators Association Inc. of Washington and director of the Alabama Securities Commission.
Most retail investors aren’t accustomed to the illiquid securities portfolios, heavy use of leverage, concentrated investments and “excessive compensation arrangements detrimental to their interests” that are characteristic of many alternative investments, he said.
The subcommittee chairman, Rep. Dennis Kucinich, D-Ohio, questioned whether adequate protections are available for Blackstone investors.
He listed the right to an independent board of directors, guaranteed voting rights, protections against self-interested transactions with affiliates and no guarantee of fiduciary duties by management to shareholders.
“The investor protections that exist now for investors investing in Blackstone and in Fortress [Investment Group LLC of New York] are those that are available to investors in securities that are registered with the Securities and Exchange Commission that are not investment companies,” replied Andrew “Buddy” Donohue, director of the SEC’s division of investment management.
Laws governing operating companies are determined by state law and the existing requirements of the exchange on which they are listed, he said.
The SEC concluded that Blackstone and Fortress shouldn’t be regulated as mutual funds, because they are engaged primarily in managing money for others, rather than investing in securities with their own assets, Mr. Donohue said.
Partnership interests
The primary assets of the companies are their general-partnership interests in the underlying funds they manage, he said.
General-partnership interests aren’t securities if the profits come from the efforts of the general partners, as opposed to the efforts of others, Mr. Donohue said.
“Their assets, sources of income, officer and employee activities, historical development and public statements are consistent with those of an operating company, not an investment company,” he said.
Shareholder advocate Mercer Bullard disagreed.
“The public offering of hedge fund managers threatens to derail the regulatory scheme applicable to investment companies,” said Mr. Bullard, an assistant professor at the University of Mississippi School of Law in Oxford and founder of mutual fund shareholder advocacy group Fund Democracy Inc. in that city.
Moreover, he said, Blackstone “simply would not be able to function if they were subject to all the requirements of the Investment Company Act.”
One member of the Oversight and Government Reform Committee questioned whether the Investment Company Act of 1940 should be re-examined in light of the Blackstone public offering.
“It is not too early to ask the question whether or not, in view of this new entity, the Investment Company Act of 1940 is up to date, and whether or not amendments need to be made to respond to the new situation in the markets in order to protect investors,” said Rep. Paul Hodes, D-N.H.
Urging caution
The ranking minority member of the subcommittee, Rep. Darrell Issa, R-Calif., cautioned against proposals being considered in Congress to raise taxes on private-equity fund managers. “One of the major recipients of both hedge funds and private equity are in fact both public and private entities, such as union pension funds, public pension funds and in fact corporate funds, typically having between 1[%] and 15% of their portfolio in these types of investments,” he said.
“These investments have done well for future retirees throughout the country, running as much as 22[%] to 23% return on investments year over year over year,” Mr. Issa said.