By STEPHEN LABATON
New York Times
July 16, 2004

WASHINGTON, July 15 - The head of the Securities and Exchange Commission staked out his independence on Thursday as he came under heavy political assault by Republican members of the Senate Banking Committee for his plan to tighten oversight of the hedge fund industry.

In a hearing with odd political dynamics, William H. Donaldson, the Republican chairman of the commission, found allies among the Democrats as he fended off skepticism of the plan by the committee's chairman, Senator Richard C. Shelby of Alabama, and more pointed criticism by most other Republican members.

The Republicans largely reiterated the complaints of some hedge funds and a hedge fund trade association - whose executives in recent months have made more than $1.5 million in campaign contributions to the two major parties. Some in the industry object to a proposal that would require all funds to register with the S.E.C. in hopes of making them transparent to regulators and investors.

Hedge funds are pools of assets and are largely unregulated. Originally open to wealthy, informed investors, they are becoming more widely available to those of more modest means and are being used with greater frequency by pension funds and other institutional investors.

The criticism Thursday was the second in two days Mr. Donaldson faced. Officials said he was questioned about the plan on Wednesday by Treasury Secretary John W. Snow and the Federal Reserve chairman, Alan Greenspan, at a private meeting of an interagency working group on financial markets. Mr. Greenspan has previously testified that the registration of hedge funds could lead to more regulations with the effect of reducing financial markets' liquidity. Mr. Snow, who has talked with executives and lobbyists opposed to the plan, has privately criticized it along similar lines, officials said.

Mr. Donaldson and other supporters reject that criticism. They say it will not reduce liquidity because it will not restrict hedge funds' legitimate trading techniques. They argue that trading in hedge funds has significant implications for others in the market - at times, they say, one hedge fund manager can be responsible for 5 percent of the New York Stock Exchange's daily volume.

Shortly before the meeting of the working group on Wednesday, the agency voted 3 to 2, with Mr. Donaldson aligned with the Democratic commissioners and against the two Republicans, to publish the proposal for public comment. It is expected to be approved this fall.

No one expects Congress to intervene by adopting legislation with so little time left in the session. But industry opponents of the plan have heavily lobbied Congress and the Bush administration in an effort to swing Mr. Donaldson back into the Republican fold.

On Thursday, he indicated that is not likely to happen. Genial but firm, Mr. Donaldson insisted that the proposed regulation would be the most effective means of shining light on a "dark corner" of a market fast approaching $1 trillion in assets. He said the plan would impose modest new costs on hedge funds and was part of a broader effort by the S.E.C. to anticipate potential market problems before they arise, costing investors huge amounts of money and threatening to undermine the stability of the financial system.

"Critics cannot have it both ways," Mr. Donaldson said. "They cannot demand that the commission be proactive in detecting and preventing emerging, but as of yet unforeseen harms, while at the same time trying to circumvent our ability to obtain information that facilitates our identification of such harms."

The plan came under sharp attack by Senate Republicans, some of it restrained and some not.

From Michael B. Enzi of Wyoming, who suggested that the commission apply its limited resources elsewhere: "The Securities and Exchange Commission may be stretching its resources too thin to protect the Warren Buffetts at the expense of ordinary investors."

From John E. Sununu of New Hampshire: "The regulations being proposed by the S.E.C. are not focused at solving a problem." Mr. Sununu said those who supported the regulation to protect pension funds were engaged in "fear mongering."

From Senator Shelby, who repeated concerns that the plan would lead to more regulation of funds and curtail legitimate investment strategies: "Is this just the beginning?" He said that in 1999, a financial working group rejected registration and asked Mr. Donaldson how significant it was that the current working group was also against the plan.

From Wayne Allard of Colorado: "People who deal with hedge funds are highly sophisticated, highly educated, and they are trading with each other. I wonder if regulators even understand how this market works."

From Robert F. Bennett of Utah: The S.E.C. staff, he said, "was looking" for new things to do, and in what some took as a thinly veiled threat, he noted, "We are involved in funding you."

Mr. Donaldson replied that he felt no compunction to vote as other Republicans had on the matter.

"I don't believe that the Securities and Exchange Commission should have anything to do with political philosophy one way or another," he said at the hearing's conclusion, "and that's why I have voted as I have. I do not believe in voting as a bloc with one political party or another."

He also said that with a growing number of large hedge funds registering voluntarily, the industry was not unified in its opposition to the plan. "I don't get much push back from people who are operating good funds," he said. "I don't get much push back from people who have nothing to hide."

His firmest supporters were Senators Jon S. Corzine, Democrat of New Jersey, and Paul S. Sarbanes of Maryland, the committee's ranking Democrat, who said the criticism of a "modest plan" was misplaced.

Mr. Sarbanes suggested the critics "ought to pause" to consider the consequences of failure by the S.E.C. to act, particularly if that were followed by an industry scandal like that associated with the collapse of the hedge fund Long-Term Capital Management in 1998.

"This may be the ounce of prevention that avoids many, many pounds of cure," he said. "I've been around here long enough and I know how it works," he said, adding that future problems in an unregulated industry could lead to more onerous legislative changes.

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