Hedge fund regulation is not working out.
Years of concern about giant pools of investment capital that were said to be under-regulated and under-taxed concluded in Dodd-Frank’s hedge fund regulation requirements and gave rise to new plans to end capital gains treatment for the profits of hedge fund managers.
But instead of kneeling down before the regulators and the tax collectors, some of the largest hedge funds are avoiding the regulation by shutting themselves off to outside investors.
First, we had Stanley Druckenmiller, who shuttered his $12 billion Duquesne Capital Management hedge fund just a month after the passage of Dodd-Frank. Druckenmiller cited his inability to meet his own performance expectations and the personal toll of working as a fund manager, rather than Dodd-Frank. But between 30 percent and 40 percent of the funds assets belonged to Druckenmiller or his associates, and he continues to manage that money. The fund didn’t shut down so much as go private—and escape the grasp of regulators.
Carl Icahn followed suit, returning the capital to his outside investors. But this represented just $1.76 billion of the $7 billion he has under management. Icahn didn’t shut down—he just shut outside investors and regulators out.
And now we learn that George Soros is going down the same path. He’s returning $1 billion of outside investor capital. Now he’ll manage just the remaining $20 billion or so personally owned by him, his family and his foundations.
This is just the beginning. Expect to hear a lot more of this sort of thing over the next few months and years. As the regulatory and tax burden increase on hedge funds, many of the most successful managers will opt to “go dark” by “going private.”
What’s clear is that the attempt to bring hedge funds out of the darkness is backfiring. Some of the largest money managers in the world, folks with the power to break the central banks of ancient nations, are retreating even further from view. Without outside investors, it will be even more difficult to track their activities.
Hedge fund regulation has backfired.
There are also tax implications of this move. If a hedge fund manager is only managing his own capital, he doesn’t have to worry if Barack Obama wants to end the carried interest exemption. The capital in his fund is all invested interest, not carried interest. The billionaires won’t be taxed like their house cleaners any time soon.
The new regulations and new taxes will certainly make it harder for the next generation of would-be Soros or Druckenmillers. Several rungs on the ladder they climbed to epochal wealth have been broken, even if the ladder hasn’t yet been kicked down entirely. Someday you may have to marry a Soros, a Niederhoffer, or a Druckenmiller if you want to benefit from the investment prowess of the greatest minds in finance.
Welcome to the feudal future of global finance.
[Editor's note: An earlier version of this story misspelled the surname "Niederhoffer." When referring to hedge fund managers Roy and Victor, it's "i" before "e."]