Hedge funds have been around for decades, but recently they have seen a sharp increase in popularity. This popularity is due, in part, to the Wall Street’s focus on the investors’ short-term benefits (or “short-termism”) and the lack of oversight over the hedge fund industry. Now, the question is whether the newly proposed Brokaw Act will help to align the hedge fund industry with this country’s long-term goals. This newly proposed legislation is intended to increase the oversight and regulation of the hedge fund industry and some of its most egregious players.

On March 17, 2016, United States’ Senators Tammy Baldwin of Wisconsin and Jeff Merkley of Oregon, both Democrats, introduced a new legislation, The Brokaw Act. It represent the first ever attempt at garnering the federal anti-activist legislation for activist hedge funds. This act seeks to increase a transparency and strengthen the oversight over the hedge funds.

The Brokaw Act is named after a small town, Brokaw, in Wisconsin. This town saw a hedge fund group take over the town’s long standing paper mill. Soon after, the paper mill went bankrupt disabling and bankrupting the entire town. This paper mill, the Wausau Paper Company, had employed the majority of the townspeople and kept the town vibrant for more than 100 years prior to the activist hedge fund buying it out. With the buyout, executives were fired and cash was used to satisfy the hedge fund’s short-term objectives, causing the bankruptcy of the company.
This is the exact type of takeover the Brokaw Act seeks to thwart.

Often, the activist hedge funds focus only on the short-term financial return of their exclusive investors, showing no concern for the affected employees, their families, and communities. Short-termism, known as “quarterly capitalism,” puts its focus on using corporate funds for huge investor payouts in dividends or buyouts instead of investments into employees, infrastructure, R&D, or other long-term objectives. If allowed to continue, this short-termism, sweeping Wall Street, may undermine many American workers, small businesses, and wreak havoc on the economy.

Activist hedge funds are leading the way in short-termism. So, The Brokaw Act proposes the following regulations in order to increase transparency and oversight of the activist hedge funds:

1. Transparency in Activist Hedge Funds
The Brokaw Act proposes to shorten the reporting time to two days. The Securities and Exchange Commission (the “SEC”) requires form 13(d,) referred to as the “beneficial ownership report,” to be filed within 10 days of anytime a person or group acquires more than 5% of a public company’s ownership.

2. Protecting Businesses from “Wolf Packs”
A “wolf pack” is a group of activist investors working together to gain a control of the corporate board. Collectively, such groups work to buy up the companies’ stock and gain control of decision making. Currently, such wolf packs avoid the Rule 13(d) disclosure requirements because, individually, each member of the pack has less than 5% of the company’s ownership. However, collectively, their stake may hold well above 5% of the company’s stock. This proposed act, however, will expand the Rule 13(d) reporting requirement to such wolf packs acting collectively to gain control of the corporate boards.

3. Derivative Disclosures
Derivatives are used to enable activist hedge funds to secretly vote against the interest of the companies in which they are invested for their own short-term financial gains. Currently, derivatives do not require any disclosure, although their impact on the price of securities and the issuer can be significant. The proposed legislation would strengthen oversight into this under the 13(d).

The activist hedge funds have grown 60% annually since 2010, and assets under their management have grown from $12 billion in 2003 to more than $200 billion today. As these hedge funds continue to grow, an increased oversight from the SEC and other regulators will be unavoidable.

This article is intended to serve as a general summary of the issues outlined therein. While this article may include general guidance, it is not intended as, nor is it a substitute for, a qualified legal advice. Your receipt of this article from Lexern Law Group, Ltd. (the “LLG”) or any of its attorneys does not create an attorney-client relationship between you and the LLG. The opinions expressed in this articles are those of the authors of the article and does not reflect the opinion of the LLG.