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Do Hedge Funds Hold 'Trade Secrets'?

Fresh from his June victory against the Securities & Exchange Commission—in which a federal appeals court tossed out a controversial SEC rule requiring hedge funds to register with the agency—Phillip Goldstein is gearing up for another battle. Within the next month or so, the activist hedge fund manager at Saddle Brook (N.J.)-based Bulldog Investors will file an application to exempt his fund from the SEC's so-called 13F rule that requires money managers with more than $100 million in stocks to disclose all holdings each quarter.

Goldstein contends that his stock holdings are "trade secrets," much like the protected formula used to make Coke (KO). His application states that complying with the 13F rule "constitute[s] a 'taking' of [the fund's] property without just compensation in violation of the Fifth Amendment to the Constitution."

While some investors and analysts have clamored for more information on funds' holdings, Goldstein says he could not find good reason for the rule. In his application, he says that the government's stated goals are to "fill an information gap" to help devise regulations and "increase investor confidence" in the U.S. markets. He argues that the SEC has not used the trading data to create regulations. And he states: "To the extent that 13F succeeds in creating investor overconfidence in the integrity of the securities markets, investors will be less likely to conduct due diligence reviews before making inherently risky investment decisions."

TO COMPLY…OR NOT. Two of Goldstein's funds, Full Value Partners and Opportunity Partners, crossed the $100 million threshold recently, so he faces a deadline in complying with the 13F rule. He says he doesn't think the SEC will approve his application for exemption from the rule. "They're just too rigid," he says. "It's a regulatory agency—everything is black and white to them."

In an interview at an investment conference in New York City on Sept. 12, Goldstein told Karyn McCormack of why he's taking on the SEC again. Edited excerpts of their conversation follow.

When will you file the application to receive an exemption from the 13F rule?

Hopefully, within the next 30 days. I've been talking to the SEC staff about it since late last year. I sent them a draft a few months ago.

They're taking it seriously. But I think they just don't know what to do with a constitutional argument—that's the problem. The chain of authority there is such that the people I talk to, the staff, I don't know if they can get someone at the highest level, meaning the general counsel's office or the commissioner's office, to really take it seriously. I guess the fact that I have credibility having brought the other lawsuit and won it, everyone knows I'm serious. And the arguments are serious.

Are you the first person to file against this rule?

There's a provision in the rule that allows managers to seek confidentiality—they still have to file with the SEC—but it's an FOIA, Freedom of Information Act, confidentiality, so it's not revealed publicly. But that's only done on a position-by-position basis.

Like Warren Buffett's investments?

Yes, he's done it. Once he filed, and at the lowest level he got rejected and he appealed it with the commission. The commission rejected it. And Warren Buffett stopped. He never went to court—he stopped at the commission level—they said no, you have to do it, and he complied. Relational, which is another big activist hedge fund, also did a similar thing.

So my feeling is, I may apply for that. Warren Buffett couldn't get it—and he's a lot smarter than me.

Why are you doing this?

I'm saying my investments, as a whole, are trade secrets. It would be like we're going to take one of your copyrighted articles, but we want to take this paragraph and take it out of the copyright. No, you can't.

There are services that say something like, why pay Carl Icahn or Warren Buffett their fees—why not just take their ideas and steal them and use them for yourself? To me, it's the same as somebody illegally downloading something from the Internet.

I admit, I do it myself. I want to know what Carl Icahn is buying. And if he has to file, I'm going to look.

But I don't think I have a right to demand that he tell me. Where does the government have this authority to make people disclose what basically are trade secrets—the source of their earnings power—without paying for it? Of course, no one pays for it and there's no way to know what it's worth.

Do you disclose your holdings now?

The accounting standards require hedge funds to make certain disclosures as to their holdings, but we've elected not to do that. We put a footnote in explaining why—we feel the costs would exceed the benefit. Therefore, we're willing to accept a qualified audit rather than disclose it.

So we've put our money where our mouth is. This is not something that just came up—we've been doing this since we started the fund. I'm not saying that everything we do is so brilliant that someone's going to steal it. But you have to do your best to protect your trade secrets.

Do you think you'll win? Why would you file this if you don't think you have a chance?

I think we have a chance. We have a good case. I thought we were going to win the hedge fund lawsuit. The judges are human beings. Are they going to see it your way? Are they going to try to find a way to give the SEC a victory?

If you go on the merits, I think we'll win. That's the same thing I said about the hedge fund case

(see, 7/17/06, "The SEC Isn't Finished With Hedge Funds"). Anybody that actually read our briefs [on the hedge fund lawsuit] thought we had a good case. But they nevertheless thought we were going to lose because they thought the court would say the SEC is the expert, let them do what they want. Thankfully, the court didn't.

Whether hedge funds register is not the biggest issue in this country. But it's important that you know that the federal courts are incorruptible. Really, to a large extent, they are.

By opposing 13F, you're protecting your investors?

Right. And there's no good reason on the other side for doing it other than, it's the law. There's no actual benefit.

If you saw my 13F filing, as a member of the public, how does that help you? It's not legitimate for you to say, Phil Goldstein, he's a pretty smart guy, I see he's buying XYZ, I'm going to buy some. That's stealing. P.J. O'Rourke had a great line in Parliament of Whores: "If enough people get together and act in concert, they can take something and not pay for it."

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