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California Backs Off Hedge Fund Regulation Plan

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Opponents of hedge fund regulation scored a win yesterday when California backed away from its plans to regulate hedge funds. Since the registration of hedge funds with the Securities and Exchange Commission was over-turned by the federal courts, several states have considered enacting their own regulatory schemes. Such moves have typically been opposed by the hedge fund industry, which has recently become active in federal and state lobbying efforts.
“California withdrew its proposal this month after many hedge fund industry officials suggested the lightly regulated investment funds could move to another state if California started regulating them,” DealBook reported this morning.
California is thought to have the largest concentration of hedge funds outside of New York, Connecticut and the Dallas area. California’s high-concentration of wealth and agreeable climate make the state very attractive to fund managers. But faced with the threat of extensive regulation, many could choose to relocate to states less prone to regulation.
“Yes, and they would take with them all those huge houses, big cars and taxes paid by hedge fund managers,” law professor Larry Ribstein explains. “California is used to having its regulatory way because many firms can’t avoid its market. But hedge funds can operate just fine without California.”
California’s surrender on hedge fund regulation nicely illustrates how federalism forces states to compete with each other, and can check excessive regulation. This is sometimes decried by critics of federalism as a “race to the bottom” but there’s little evidence to suggest that states are forced to lower regulatory levels on investment managers to below optimum levels. If investors desired more hedge fund regulation, hedge funds would have financial incentives to locate in states with greater regulations. Hedge fund investors, however, seem to doubt that they would benefit from new regulations that go beyond traditional legal strictures against things like theft and fraud.
California Drops Hedge Fund Proposal [DealBook]
Hedge funds and jurisdictional competition [Ideoblog]