Hedge Funds and Private Equity in the Crosshairs

A version of this post previously appeared in The Hill.

As the calendar turns to 2016 and an election cycle looms, politically-charged rhetoric is once again pouring down on the capital markets. Congressional leaders, federal regulators and both major parties’ presidential candidates are ramping up their scrutiny of financial institutions and investment managers. But of all the pieces that comprise Wall Street, the alternative asset management sector faces the greatest challenges heading into the New Year.

In appealing to the American electorate’s belief in economic fairness and equal opportunity, presidential hopefuls—ranging from Hillary Clinton to Donald Trump—are ramping up critiques of the hedge fund and private equity worlds. Senator Bernie Sanders (I-VT) recently declared in a Huffington Post op-ed that it is “disgraceful that millionaire hedge fund managers are able to pay lower effective tax rates than truck drivers or nurses.” Secretary Clinton has also been touting that “we need more accountability, tougher rules and stronger enforcement” on Wall Street.

While candidates are raising their own voices, there is comparable noise inside the Beltway. The College for All Act, which includes a proposed financial transaction tax, and the Carried Interest Fairness Act of 2015 were both introduced during the 114th Congress. The Securities and Exchange Commission also recently reported its FY15 results, which includes more than 800 enforcement cases and a record 507 independent actions for violations of the federal securities laws. This past year’s first-of-their-kind cases included action against a private equity advisor for “misallocating broken deal expenses” and the pursuit of violations stemming from “a dark pool’s disclosure of order types.”

Looking ahead, we see a number of issues that alternative asset managers should look to monitor and potentially address in 2016, including:

  1. Campaign trail attacks will be louder than ever.

It is no secret that hedge funds and private equity firms remain a political target, but the personalities in this particular presidential field will further exacerbate the divide between Main Street and Wall Street. Senator Sanders’ views on curbing and taxing alleged investment speculation will push Secretary Clinton to further reinforce her own strengthened regulatory positions. Republicans, while advocating for more streamlined oversight, share plans to end preferential treatment afforded to investment partnerships under the carried interest provision.

  1. Carried interest will remain front-and-center.
    Given that presidential candidates are continuing to fine-tune their respective tax plans, they will need to discuss carried interest. But both Democratic and Republican frontrunners realize that a majority of Americans—now more familiar with the existing provision—want the carried interest loophole stitched up through comprehensive tax reform. Needless to say, candidates competing for fly-over state support will find it difficult to defend a policy that positions them as an ally of Wall Street.
  1. There is populist support for a financial transaction tax.
    Amongst younger voters and those disillusioned with the financial sector, Democratic candidates are finding support for a transaction tax that would impose a levy on securities trades. Proponents suggest a tax of roughly 0.05 percent will help curb speculation and mitigate the downside of high frequency trading strategies while simultaneously generating revenue to subsidize higher education programs or social initiatives. Although Republicans label the tax as a non-starter that a Democratic president could not push through the Congress, expect Main Street support for the idea to increase.
  1. High frequency trading will remain a convenient buzz phrase.
    Our evolution to electronic financial markets has created confusion around the differences between algorithmic trading, high frequency trading and low latency trading.  The release of Flash Boys compounded the general public’s concernand has placed electronic trading in politicians’ sights.  With congressional democrats proposing new market structure oversight and federal regulators crafting rules specific to order cancellation, the manner in which quantitative traders act within the modern markets will remain a topic conversation in 2016.

In sum, Dodd-Frank’s facilitation of private fund registration and swaps market reforms is not quelling the angst directed at alternative asset managers. The only way firms can begin to address misconceptions and credibly advance their own policy positions is by further humanizing themselves in the eyes of lawmakers and ordinary Americans. This means aligning with peers to educate the non-financial world on the role hedge funds and private equity firms play in helping endowments, public trusts and pensions funds meet their long-term investment goals.

While hedge fund and private equity entities are well represented by various industry associations, it will take new and innovative communications strategies to truly change public perception. Now is the time for principals and partners to begin leading this path forward.

Mike Geller is an executive vice president in New York with Edelman Financial Communications.
Greg Marose is an account supervisor in Washington, D.C. with Edelman Financial Communications.