The Future of Financial Services

Updated from Feb. 23

From the Wall Street research scandals that took place during the tech/telecom boom of the 1990s to the current mortgage/credit crisis, many banks and brokers have gone out of business or have been acquired. (Don't miss "New Bank Failures: Week of Feb. 23"). But you probably already knew that.

So with the financial services industry being reshaped (via legislation, natural evolution or both), what will this world of banks, brokers, mortgage companies, insurers, hedge funds and credit card companies look like on the other side of this crisis?

Here's the first of a two-part look at how things might change (here's part two).

Investment Vehicles

Whether or not Bernie Madoff (Photo Gallery: Madoff) or Robert Stanford (Photo Gallery: Stanford) operated as hedge funds is not the issue. The focus will be on how we can best regulate investment vehicles and protect investor interest.

In general, investors have money managed in three types of investment vehicles: mutual funds, separate accounts (I manage separate accounts through my company LakeView Asset Management) and hedge funds.

I expect that mutual funds, which were in somewhat of a decline since the dot-com bubble burst, will begin a second life, despite the inefficiencies in their structure. The reason: Mutual funds are registered vehicles that must file regularly with the SEC and those filings are publically available for anyone to view. By extension, I think that the burgeoning exchange-traded fund (ETF) industry will continue to expand and diversify its offerings.

Hedge funds are in real trouble. A prior attempt to regulate this industry failed. However, given the recent scandals and a new administration in Washington, I believe that significant changes are coming.

It's probable that the funds and their managers will be required to register with a regulatory agency and submit quarterly audited reports just like mutual funds. I envision a repeal of the regulations that allow a hedge fund manager to earn performance fees. Eliminating the performance fee would no longer limit the funds to accepting accredited investors. If that does not occur, then at the very least, expect a change in the tax law, which currently treats performance fees as capital items rather than ordinary income.

The unintended consequence of these actions might be that hedge funds will begin to operate more like mutual funds. In fact, I would not be surprised to see hedge funds begin to issue shares -- open or closed-end -- to the public.