Do Systemic Externalities Render the Public-Private Dichotomy Irrelevant? The Case of US Private Fund Regulation

This paper studies the interplay of the public-private dichotomy and the externalities argument in the context of recently enacted U.S. “Private Fund Investment Advisers Registration Act of 2010”. Having conducted a historical overview of the concept of public and private domains in constitutional law and economics, the private fund regulation will be analyzed in the context of constitutionally demarcated public-private divide. The main question involves the viability of the traditional framework dividing public and private domains in analyzing regulatory responses to the private funds' potential systemic externalities. It is argued that due to the interconnectedness of public and private businesses, (systemic) externalities arising from private businesses and spilling over into the public domain overshadow the traditional framework of legal analysis which is based on the public-private dichotomy. It is further argued that systemic externalities, if cannot otherwise be constrained, transform the private nature of activities into public and hence the public intervention in the form of regulation may be justified. This paper further studies the two-pronged approach to addressing risk spillovers in the Dodd-Frank act in light of the public-private dichotomy. First, the recent extension of government regulation to directly regulate private funds through imposing registration, reporting, record keeping, leverage and position limits are criticized not only because of its potential adverse economic consequences on private funds and social welfare, but also because of its aggressive intrusion into the economic freedoms and immense delegation of discretionary powers to regulatory agencies. And second, the attempt to indirectly regulate private funds through separating them from quasi-public financial institutions such as banks by introducing the Volcker Rule (or the so-called Glass-Steagall lite) is commended on the grounds of its potential to insulate the systemic externalities of the private funds while being less intrusive to the private domain and economic freedoms