US-China Commission Report - Fatal System Error

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not be applied necessarily in the same way to organizations that
are a part of the government that makes the rules, and the opportunity
for political corruption increases. 249
For the SEC, which is charged with investor protection, sovereign
wealth funds raise a number of problems, chief among them
‘‘the fact that the ability of U.S. supervisors to govern sovereign
wealth funds is mostly unclear.’’ 250 Like other participants in the
U.S. capital markets, sovereign wealth funds are subject to federal
securities laws, including a variety of disclosure requirements and
antifraud provisions, generally found in sections 13 (Periodic and
Other Reports) and 16 (Directors, Officers, and Principal Shareholders)
of the Securities Exchange Act of 1934. 251 Neither international
law nor the Foreign Sovereign Immunities Act renders
these funds immune from the jurisdiction of U.S. courts in connection
with their commercial activity conducted in the United States.
These provisions include requirements that
Owners of more than 5 percent of a registered class of securities
disclose their share ownership and any plans for influencing
or taking over the issuer;
Institutional investment managers with discretion over accounts
holding more than $100 million of SEC-registered
securities file quarterly reports on all SEC-registered securities
in the accounts; and
Owners of more than 10 percent of a class of equity securities
registered with the SEC report on the size and composition
of their holding and on changes to that ownership. 252
There are serious enforcement issues associated with sovereign
wealth funds, however. They are relatively opaque and, ‘‘by virtue
of their substantial assets,’’ have ‘‘substantial power in our financial
markets,’’ which makes them similar to hedge funds that also
are opaque. 253
Hedge and private equity funds are virtually unregulated in the
United States. They provide vehicles for CIC and other Chinese
state-controlled entities legally to hide their investments from public
view. CIC’s investment of a reported $4 billion with J.C. Flowers
& Co., a New York-based private equity firm, provides an illustration
of how this can work. CIC’s investment reportedly represents
80 percent of the newly created Flowers fund. If this fund in turn
purchases 10 percent of a publicly traded entity in the United
States, the only disclosure precipitated by the transaction will be
various filings with the SEC requiring information about the J.C.
Flowers entity to be revealed, but not the underlying fact that CIC
is an 80 percent investor in the vehicle that purchased 10 percent
of the firm. Nor, for that matter, is there any disclosure requirement
if the other 20 percent of the Flowers fund were held by other
Chinese state-owned entities, if that were in fact the case. Disclosure
of material information is the underpinning of the U.S. securities
markets. But current disclosure rules do not appear uniformly
to force the revelation of the routine investments (after the fact) by
CIC or other sovereign wealth funds in the U.S. public securities
market. Yet thousands of U.S. institutional investment managers