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July ABI Journal Article Details Dodd-Frank Acts Potential Effects of Increased Creditor Oversight on Hedge Funds

Alexandria, Va. — While the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 was meant to build a more efficient, transparent and stable financial system, its provisions related to hedge funds may have some unintended and undesired consequences, according to an article in the July ABI Journal. “With the number of hedge funds in the thousands, some may be unable to leverage while some may utilize bankruptcy to avoid creditor pressure,” S. Ari Mushell of Americans United for Government Reform (New York) writes in his article, “Dodd-Frank and Hedge Funds: An Uneasy Fit.” Prior to the enactment of Dodd-Frank, Mushell said that hedge fund creditors lacked the effective ability to monitor a debtor hedge fund's activities because the shadow banking system allowed a fund to avoid scrutiny. A creditor could force a hedge fund not paying its debts into an involuntary bankruptcy, but this option was unattractive because of the gap period subsequent to an involuntary bankruptcy petition and the likelihood of §303 penalties. As a result, the system during the financial crisis essentially restrained a creditor from scrutinizing a debtor hedge fund. To create a more stable and transparent financial system, Mushell writes that the Dodd-Frank Act requires Security and Exchange Commission (SEC) registration of hedge funds with more than $150 million in assets and more than 15 U.S. clients, with small hedge funds registering with state agencies. Specifically, hedge funds must provide information about their trades and portfolios to regulators. The idea of the disclosures was to end “the ‘shadow’ financial system, wherein regulators relied on ‘indirect’ information provided by a hedge fund's creditors and counterparties,” Mushell writes. By utilizing Dodd-Frank’s regulation tools, a creditor can determine how many assets a debtor hedge fund is holding, but this regulation may have unintended consequences. “If a creditor feels that the debtor hedge fund's debt ratio is too high, the creditor may place pressure on the hedge fund to limit its activity and/or settle its account with the creditor to preserve its business model and restructure its debt,” Mushell writes. “The Dodd-Frank-initiated creditor oversight of hedge funds may in fact pull a hedge fund toward or away from bankruptcy.” To obtain a copy of “Dodd-Frank and Hedge Funds: An Uneasy Fit,” published in the July issue of the ABI Journal, please contact John Hartgen at 703-894-5935 or via email at jhartgen@abiworld.org. ### ABI is the largest multi-disciplinary, nonpartisan organization dedicated to research and education on matters related to insolvency. ABI was founded in 1982 to provide Congress and the public with unbiased analysis of bankruptcy issues. The ABI membership includes more than 13,000 attorneys, accountants, bankers, judges, professors, lenders, turnaround specialists and other bankruptcy professionals, providing a forum for the exchange of ideas and information. For additional information on ABI, visit www.abiworld.org. For additional conference information, visit http://www.abiworld.org/conferences.html.