As the California legislature approaches its final recess of the current session, it is continuing to move AB 3129 (Wood), a bill that would according to the bill's digest "require a private equity group or a hedge fund, as defined, to provide written notice to, and obtain the written consent of, the Attorney General before a transaction between the private equity group or hedge fund and a health care facility, provider, or provider group, as those terms are defined, and any of those entities that directly or indirectly control, are controlled by, are under common control of, or are otherwise affiliated with a payor, except as specified". Today's post focuses on the legislature's bizarre definition of "hedge fund".
Although commonly used, the term "hedge fund" is notoriously imprecise. In a 2003 Securities and Exchange Commission Roundtable, David Vaughan provided more than a dozen definitions of the term. The SEC's website provides the following generic description:
Like mutual funds, hedge funds pool investors’ money and invest the money in an effort to make a positive return. Hedge funds typically have more flexible investment strategies than mutual funds. Many hedge funds seek to profit in all kinds of markets by using leverage (in other words, borrowing to increase investment exposure as well as risk), short-selling and other speculative investment practices that are not often used by mutual funds.
The legislature's proposed definition is as follows:
(A) “Hedge fund” means a pool of funds managed by investors for the purpose of earning a return on those funds, regardless of the strategies used to manage the funds. Hedge funds include, but are not limited to, a pool of funds managed or controlled by private limited partnerships.
(B) “Hedge fund” does not include:
(i) Natural persons or other entities that contribute, or promise to contribute, funds to the hedge fund, but otherwise do not participate in the management of the hedge fund or the fund’s assets, or in any change in control of the hedge fund or the fund’s assets.
(ii) Entities that solely provide or manage debt financing secured in whole or in part by the assets of a health care facility, including, but not limited to, banks and credit unions, commercial real estate lenders, bond underwriters, and trustees.
While this definition does include the concept of pooling of funds, other aspects of the definition are strange. For example, hedge funds are typically not managed by investors in those funds. Rather, they are managed by a manager who may, or may not also, be an investor in the fund. Thus, a plain reading of the definition would exclude many funds that would generally be regarded as "hedge funds". The the definition specifically includes pools of funds managed or controlled by private limited partnerships. However, the typical fund is structured as a limited partnership or limited liability company that is managed by a general partner or manager, case may be. Typically, the general partner or manager of a fund is not itself a limited partnership.
Given the multiplicity of definitions of the term "hedge fund" the legislature's struggle with defining the term is somewhat understandable. However, the legislature should not enshrine such a bizarre definition into law.
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