Disclosure for Alternatives: Introducing Reg Alt D

Hedge Funds and Private Equity Need Full Disclosure
Many function just like mutual funds or ETFs, yet operate behind a veil of secrecy.
Bloomberg, November 19, 2019




The U.S. Securities and Exchange Commission is considering letting nonaccredited investors  put money into closely held investment pools such as hedge funds, private equity and venture capital.1  This alone is reason to reconsider the issues of transparency and disclosure by these investment alternatives.

Unlike mutual funds or exchange-traded funds, these pools of investment capital don’t have to provide much in the way of transparency. True, they must register with the SEC if they are large enough, but beyond that they don’t have to disclose much of anything. They don’t have to disclose the amount of assets under management, list their biggest holdings or reveal investment returns. They don’t even have to disclose the identity of their senior managers.

The SEC should mandate public disclosure of the details mentioned above.

Now having said that, I don’t believe every investment fund should be required to disclose this information. Funds that just accept the money of a limited number of wealthy individuals can keep doing whatever it is they’re doing behind the veil. But the SEC should mandate full disclosure for investment funds that accept money from public pensions, college endowments or not-for profit foundations. It also should require disclosure for funds in which the partners get a tax benefit from the carried-interest loophole, which lets them pay taxes on their earning at rates about half those on regular income.

This broader disclosure would accomplish at least three things:

First, it would help prevent the sort of fraud that seems to occur so regularly in this space. Everyone knows about the high-profile cases like Bernie Madoff‘s Ponzi scheme; there are plenty of other examples of fraud in hedge funds, and occasionally private equity and venture capital, too. The requirement of audited financial statements from a well-qualified accounting firm might have blown the whistle on some or even most of the scams.

Second, there is a huge funding gap between future obligations and assets among state pension funds: The shortfall is estimated at $1.28 trillion and is forecast to get bigger.2  These pensions have had widespread exposure to so-called alternative investments, mostly to their detriment. More comprehensive disclosures would allow better and more informed decision-making.

Third, a broader data set would help quantitative managers, allocators and academics to create a robust set of analytical tools to assess closely held investment funds. It is an area that is crying out for a review to determine how and where value is created and how investors should risk their capital. Just imagine what the academic world could do with that rich vein of information.

Those with libertarian leanings will argue that these are private pools of capital whose limited partners are sophisticated and the funds themselves are designed for accredited investors with the means, professional staff and self-interest to investigate the data themselves. Thus, there is no need for costly regulatory paternalism; the private market will work itself out.

That might sound good in theory, but decades of data demonstrate it does not work in practice. Institutional investing is staffed with humans who make all of the same errors as individuals, just within a more sophisticated and typically more costly framework. Pension funds and endowments all show a discomforting tendency to chase expensive investments after a period of good performance — and all too often after the hot streak is over. We have a looming retirement crisis in this country, and greater transparency and disclosure will only help led to better and more informed investing decisions.



1. State pension funds and college endowments are making investments on behalf of non-accredited (read small) investors in hedge funds, venture capital and private equity. If you are a teacher, police officer, college professor, fireman or any other public employee, the odds are that your pension fund already has exposure — and in many instances, substantial exposure — to these funds; you probably just don’t know it. This is reason enough to mandate transparency and disclosure rules.

2. Today’s labor force will not have sufficient resources to retire at traditional ages or with their expected standard of living as detailed by Charles Ellis in “Falling Short: The Coming Retirement Crisis (and What to Do About It).”





I originally published this at Bloomberg, November 19, 2019. All of my Bloomberg columns can be found here and here



Print Friendly, PDF & Email

Posted Under