Posted on 01/29/2006 9:18:20 PM PST by NormsRevenge
WASHINGTON - As financial lore has it, five pals scraped together $100,000 in 1949 to start what became the first hedge fund. Their ringleader and mastermind, Alfred Winslow Jones, was a Fortune magazine writer and former U.S. diplomat who had a bold new idea.
Today some 7,000 hedge funds in the United States command an estimated $750 billion to $1 trillion in assets and leave a wide footprint in the financial markets, as they are believed to account for as much as 20 percent of all U.S. stock trading. They're about to be brought under new supervision by federal regulators concerned about their explosive growth and virtually unbridled operations.
But some big hedge funds are using a loophole to get around the new oversight, and the new regulation itself is being challenged in the courts.
Under a rule that bitterly divided the five-member Securities and Exchange Commission when it was adopted in October 2004, a new regime begins on Wednesday for these high-risk, largely unregulated and secretive investment pools. Hedge funds have traditionally been the investment domain of the wealthy but have become popular with small investors in recent years.
Soon after SEC Chairman Christopher Cox assumed that position last summer, he signaled that he wouldn't seek to overturn or revise the controversial rule adopted under his predecessor.
Institutional investors such as pension funds, 401(k) retirement plans and university endowments also increasingly have been pouring billions into hedge funds, lured by the prospect of high returns even in a down market.
"Hedge funds have become increasingly sexy for the average widow, widower and orphan," says James Cox, a Duke University law professor who specializes in securities law.
At the same time, SEC regulators have seen an upswing in fraud among hedge funds in recent years, and the agency has been bringing more enforcement cases against them — 51 in the last five years charging fund managers with defrauding investors of a total exceeding $1 billion.
"We are seeing a growing number of enforcement cases on our ... docket at a time when the growth and popularity of hedge funds have increased dramatically," said Robert Plaze, associate director of the SEC division that oversees hedge funds and mutual funds.
Under the SEC rule, most hedge fund managers now must register with the agency. That opens the funds' books to SEC examiners and makes them subject to an array of regulations including accounting and disclosure requirements. The examiners will be able to conduct inspection "sweeps" of hedge funds.
Thousands of hedge fund managers have already voluntarily registered. But some big hedge funds are using an exemption to avoid having to register — though SEC officials say it's not a loophole; they call it "an element in the definition of 'private fund' that is designed to distinguish between hedge funds and other types of funds."
The new rule applies only to those funds that allow investors to redeem their stakes within two years of buying them. The hedge funds in question are extending the so-called "lockup" period to two years.
Hedge funds profit by using unconventional techniques that are off-limits to mutual funds, such as short-selling, or betting on falling stocks or markets to make a profit from downturns. They also use derivatives, complex financial instruments used to hedge against risk, futures contracts and commodities options. Hedge fund traders are particularly aggressive and nimble, darting in and out of investments.
Other elements of the drama that has been playing out in the hedge fund world in the last days before its new regulatory regime:
_In September, two top officers of the scandal-ridden Bayou hedge fund suddenly emerged from hiding and admitted engaging in a fraud that totaled hundreds of millions of dollars — $450 million according to court papers. They pleaded guilty to conspiracy and fraud charges in federal court in White Plains, N.Y.
Daniel Marino, who was Bayou's chief financial officer, had written a suicide note last summer that was discovered by police. It was the most spectacular in a series of recent hedge fund scandals.
_In a Washington courtroom last month, judges on a federal appeals court panel hearing oral arguments questioned the SEC's legal authority to impose the new regulations on hedge funds. A lawsuit against the agency filed by hedge fund adviser Phillip Goldstein and fund partnership Opportunity Partners is still pending.
When the hedge fund rule was adopted in 2004 it split the five SEC commissioners. One of the two who voted against it, Republican Paul Atkins, even said at the time that there are "serious questions" about the agency's authority in the matter.
_What will they think of next? Perry Capital, a $10 billion hedge fund, used a complex technique to get the power to vote a company's shares in favor of its takeover bid for a rival — without having any money at risk. The SEC recently notified Perry that its enforcement attorneys are preparing to bring civil charges against it.
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On the Net:
SEC guide to hedge funds: http://www.sec.gov/answers/hedge.htm
Maybe they should raise the minimum net worth requirements instead of regulating it. Caveat Emptor.
I thought it was a horticulture pool for buying hedges. What could be wrong with that?
Maybe they should do a better job of enforcing the regs they already have.
I agree, 'sophisticated investor' status should be a requirement to buy into any of these funds.
These fund managers are relying on new technologies and trading strategies to keep them afloat, if one big one goes belly-up, the market could tumble.
With GM and Ford in trouble, it isn't rocket science to figure out that anyone with big bucks and an IQ higher than room temperature is putting most of their money in real estate.
But the stock brokers don't know that their rich clients are only giving them 1/6th of their business, the other 5/6th is going into real estate.
SEC is a joke just like the FEC.
And that will probably happen. There is no way to take all risk out of stock market investing. Portfolio insurance didn't work either.
The main problem with hedge funds in recent years is that they have opened it to people who shouldn't have participated in the first place. Hedge funds were traditionally investment pools for the very rich, not meant for the mass market.
This was a long time coming. I always wondered why FDR left hedge funds alone when he created the SEC.
The SEC's basic requirements for listing and public disclosure of financial reports has worked quite well. Other than that, they are just like any government bureaucracy.
The Refco implosion just scraps the tip of the iceburg of whats going on in hedge funds like these.
The naked shorting that goes on to manipulate the markets could easily crash the entire market if exposed.
Long-Term Capital is probably the classic case to-date.
I guess my fund manager is way ahead of the curve. I had to establish that I was a "sophisticated investor" years ago to participate in his fund.
And that bubble is about to burst.
"Hedge funds were traditionally investment pools for the very rich, not meant for the mass market. "
Exactly. I think the minimum requirements for an "accredited investor" has not kept pace with wealth inflation.
Any form of market investment is gambling. This form of gambling just brings out a little better dressed group of whores.
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