Hedge fund is a new name for an old game. In the 1920s they were called investment pools and the most important denominator of the two vehicles is that they lack any regulation, making them prone to cut corners in an investment climate that has changed since 2000. According to the NYT hedge funds nowadays account for as much as 30% of trading activity. It is estimated that the almost entirely unregulated investment pools manage more than $1 trillion in assets.
While all this is a recipe for market manipulation, SEC chairman Christopher Cox has declined to ask Congress for for additional authority to police the industry.
From the NYT:
Among the measures Mr. Cox will recommend to the commission is changing the rules on who can invest in hedge funds, increasing the net-worth threshold for an individual or couple to $1.5 million or more from $1 million today.I think it is obvious that leveraged hedge funds/investment pools pose a risk to markets in the climate of an inverted yield curve. Why is it that the USA - so eager to police each and everything around the globe - takes a hands-off attitude towards these potential market manipulators?
"I am concerned that the current definition, which is decades old, is not only out of date but wholly inadequate to protect unsophisticated investors from the complex risks of investment in most hedge funds," he said.
But when pressed by senators about whether he needed more authority to regulate hedge funds, Mr. Cox replied, "I am not prepared to say yes or no. Our review of our different authority is still ongoing."...
...The commission has the authority to investigate any kind of fraud it suspects, but the court's decision to throw out the registration requirement limits its ability to conduct routine exams and improve its understanding of the industry.
Some lawyers said Tuesday that they were not surprised that Mr. Cox did not ask Congress for more authority.
"I think there is some reticence by regulatory agencies overall to admit a need for, or affirmatively ask for, help from Congress,” said Jim C. McCarroll, a partner at the law firm Reed Smith who focuses on hedge funds and funds of hedge funds. "They prefer to exercise their individual regulatory authority before seeking a legislative fix."
Mr. Cox explained some of steps he would ask the commission to take to reclaim some of the authority it had lost when the court declared its registration requirement invalid.
For example, the Investment Advisers Act has strict rules on what books and records must be kept to back up performance data. The registration rule required hedge funds to have those books and records after the funds registered, but exempted them from having them for periods before they registered. Mr. Cox said he wanted that exemption to be reinstated.
Mr. Cox also said he would introduce a measure to permit the commission to sue managers on behalf of investors in the fund.
Mr. Cox said 10 hedge funds had withdrawn their registrations since the appeals court decision, but more had registered. "Although these are early returns and may not be indicative of the final outcome, we have actually experienced a net increase in the hedge fund registration," he said.
The Treasury Department, meanwhile, has formed a group to examine potential risks in the industry, including the exposure that many large banks could have to certain trades. The group, which first met a few weeks ago, will work with members of the hedge fund industry and the banks who manage their accounts.
The 1998 near-collapse of the hedge fund Long-Term Capital Management was invoked several times during the hearing.
In his testimony, Randal K. Quarles, under secretary for domestic finance at the Treasury Department, asserted that the conditions that had led to that spectacular near-collapse were not as prevalent today.
"There is reason to believe there is less risk posed by the hedge fund industry than in the past," he said, including less leverage, less concentration of risk and more awareness by the banks that manage the hedge funds' accounts.
He said one risk he saw was embedded leverage, or bets that hedge funds have taken with derivatives that are less apparent on the balance sheet.