My linking earlier today to this Wall Street Journal piece by Hal Scott and John Gulliver prompted a Cafe Hayek patron to send to me the following e-mail. I asked this patron for permission to share it here; permission was granted on condition that the patron remain anonymous.
By way of background, I work in a hedge fund advisory firm as an executive officer and have done so–at a number of different advisory firms–for the past 25 years or so. Over that time, no area has changed more profoundly, or wrongheadedly, than “compliance”. In the late 90s, the remarkably clearsighted and sensible view that because investors in hedge funds were almost universally ultra-sophisticated it therfore made sense to leave with them the burden of compliance held sway. Over time, and for a variety of reasons, the belief in self regulation on the part of the industry’s participants has all but vanished. The current head of the SEC, to the contrary, seems to believe that the industry can only function if every aspect of its conduct is subject to exacting regulation, if you judge by the quantity of regulatory output during his regime. He and his SEC acolytes apparently cannot understand how arrangements freely negotiated and agreed to amongst sophisticated parties that have many choices available to them can possess qualities that are beneficial to industry functioning and all industry participants.
The ultimate irony, of course, is that this regulation makes the industry less competitive and robust, as it serves to entrench the bigger players in the industry. These large advisors can easily afford to bear the costs of the regulation, and therefore may warmly embrace it (in the name of industry “best practice”, which is nothing more than a privileging of the practices those larger firms have adopted) and its cartelizing effects. The smaller and younger-vintage fund managers, those that often produce the best returns for investors, are left trying to figure out how to manage the costs and complexities associated with ever-growing regulation. The inevitable upshot is an industry with an artificially large preponderence of the former relative to the latter.