Panel targets hedge funds
Members of Congress on Wednesday had a message of caution for the booming, unregulated hedge fund industry: Proceed with care, because lawmakers are increasingly willing to clamp down to ensure integrity in the marketplace.
“I don’t think anybody can be confident that all’s entirely well here,” said Rep. Barney Frank (D-Mass.), chairman of the House Committee on Financial Services. “It’s a matter of concern.”
Frank later told reporters he might introduce legislation this year that would require hedge funds to save various documents, such as trading records and e-mail, that could be of use to law enforcement officials in cases of fraud.
Also Wednesday, the Securities and Exchange Commission approved a rule affirming its ability to sue hedge funds for fraud. The SEC action followed a legal decision that tossed out a previous SEC rule requiring the funds to register with the agency and provide certain information.
“This rule will give the commission an important tool to help us police this market to deter misconduct,” SEC Chairman Christopher Cox said.
The developments underscored growing fears that private investment pools such as hedge funds could spread instability throughout the financial markets. As warning signs, lawmakers cited the ongoing woes involving mortgage-based securities, the recent bailout of two hedge funds by Bear Stearns Cos. and an ill-fated investment by San Diego County’s retirement fund in the Amaranth Advisors hedge fund.
Hedge funds use an array of trading techniques to pursue lucrative returns, sometimes shifting strategies with dizzying speed and often taking on debt in their attempts to enhance the payoff. By some estimates, they are worth $2 trillion in aggregate.
In February, the President’s Working Group on Financial Markets contended that the free market would be the most effective form of discipline and rejected calls for new rules that would require hedge funds to operate more transparently, under federal oversight.
“There is a laser-like focus in the markets” as the most effective instrument to manage risk, Federal Reserve Gov. Kevin M. Warsh said Wednesday.
But many in Congress remain skeptical that an unregulated market is the solution. At Wednesday’s hearing, members of the House financial services panel made their views known to officials with the Federal Reserve, the Treasury, the SEC and the Commodity Futures Trading Commission.
Lawmakers pointed out that the meltdowns of the Amaranth and Bear Stearns funds occurred against the backdrop of a healthy financial system. In different ways, they asked: What would happen if such problems arose at a time of financial instability?
“We hope self-regulation can be the order of the day,” said Rep. Paul E. Kanjorski (D-Pa.). “If it fails, the Congress will be called upon to move in very swiftly and very deeply.”
Pension assets that are increasingly invested in hedge funds are among lawmakers’ concerns. The prime example is an episode involving the San Diego County Employees Retirement Assn., which invested $175 million in the Amaranth Advisors fund that later collapsed. Pension officials have accused Amaranth of deception and brought suit.
Rep. Richard H. Baker (R-La.) on Wednesday said the episode suggested that ordinary workers like teachers and firefighters face potential risks to their retirement funds in different parts of the country.
Others on the panel expressed unhappiness about the widespread real estate foreclosures and mortgage delinquencies, which have spread jitters on Wall Street. Bear Stearns has said it would put up $1.6 billion to rescue a hedge fund that was hammered by losing bets involving high-cost mortgage bonds and other nontraditional securities.
“Why didn’t you see this coming?” Rep. Maxine Waters (D-Los Angeles) asked the assembled regulators.
Although recent turmoil has prompted calls for greater oversight, some on Wednesday expressed doubts. Critics of regulation have argued that U.S. financial markets are losing their competitive edge because of excessive red tape and that private industry is equipped to regulate itself.
“The last thing we ought to do is drive investors, whether it’s hedge funds or private equity funds, offshore,” said Rep. Spencer Bachus (R-Ala.), the senior Republican on the financial services panel.
Frank’s proposal to require hedge funds to retain documents also prompted a negative reaction from an attorney who had litigated many cases on behalf of such funds.
Perrie Weiner, a partner with law firm DLA Piper in Los Angeles, termed such a mandate “extreme and unjustified” and said document retention had never been an issue in cases he was familiar with.
“It would create a new and unjustifiable burden on ordinary businesspeople that can only be viewed as a harbinger for an emerging witch hunt of epic proportions,” he said.
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