Developing a Cost-Benefit Framework for Future Evaluation of SEC Mandatory Disclosure Regulation of Hedge Funds under Dodd-Frank

This paper analyzes the information provision requirements placed on hedge funds in Title IV of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Because the legislation and rulemaking are yet to be implemented, I use three historical examples of similar information provision policies to identify areas of costs and benefits relevant to information disclosure policy. With these categories of costs and benefits established, I create a framework for consideration by economists in future cost-benefit analyses of the rule. The 1934 Securities Exchange Act, the 1960 Amendments to the Investment Advisers Act, and the 2004 SEC decision to mandate hedge fund information disclosure are unique policy events that provide the investigative background of the relevant costs and benefits of the SEC’s mandatory disclosure policies. Language from these statutes is the backbone for Dodd-Frank Title IV, which amends Section 204 of the Investment Advisers Act to include hedge funds in the SEC disclosure regulation scheme. Research and analysis of historical disclosure policies furnishes specific categories of costs and benefits to create a framework for future analysis. The relevant areas include the following categories: firm level cost of compliance with regulation; market-wide cost of decreased hedge fund activity, capital formation, and liquidity provided by funds; market-wide cost of decreased hedge fund incentive to uncover price information and add transparency to markets; the societal cost or benefit of funding a larger SEC bureaucracy and regulatory regime; decreased risk of system-wide shock and crash; and the increased ability of the SEC to monitor and deter fraud and insider trading by hedge funds.
My research shows that the historical models suggest the benefits of mandatory disclosure to the SEC may outweigh the costs of this regulation. However, empirical uncertainties in certain categories provide caution before stating a definitive answer to the question. Further research in 5 to 10 years should provide clearer definitions of the magnitude of these costs and benefits.