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October 20, 2005

Should lawmakers tighten the noose on hedge funds? Thurs., Oct. 20, 2005, 9:18 AM

Steven Pearlstein, a business columnist with The Washington Post, seems to have a grasp on the problems with hedge funds. He writes in an interesting article today:

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At a minimum, hedge funds should be required to send audited, quarterly statements to investors and the SEC. With college endowments, insurance companies, pensions and mutual funds now so heavily invested in hedge funds, this has gone well beyond protecting rich investors."

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Few people in the industry want more regulation, but the problem is that Self-Regulatory Organizations (SRO) and government regulators like the SEC have failed the public. As the problems worsened, it has been the New York State and the U.S. Attorney's offices that have in a sense protected the public by laying criminal charges against industry miscreants. Now it is up to the lawmakers to examine what is wrong with the system itself.

I worked for many years in the securities industry, and I'm proud to say that most of the people I worked with were hardworking professional types. But the laws and the rules and regulations are full of conflicts so bad that the public will never be well served by the securities industry and its self-regulatory structure.

I think the public is expecting too much of the present system. I also believe that the SEC's Christopher Cox has a duty to get to the bottom of the problem, so that lawmakers in Washington can see what they have to do to make fundamental changes for the good of society.

I refer to global society" because there isn't a major piece of securities legislation in the world that is not based on the American model. Regulators in all countries are waiting to see how the Americans handle this hedge fund and derivatives trading problem.

You know, there are police authorities in many countries that don't take the same view as their counterparts in America. I referred to that issue when I once wrote an article named (I think): They shoot bankers don't they."

You see, once we go down this road of leaving securities regulation in the hands of criminal prosecutors, the problems will be overlooked, and for sure they will continue. America, for example, has a prison population as a pct of its total population that is one of the world's highest.

If white-collar criminals are increasingly added to the mix, the jails will need to be built larger, but the source problem will not be solved.

Another article I read today about industry recommendations for changes related to hedge funds discusses the views of David Swensen, who manages Yale University's $14 billion endowment fund.

Swensen says that hedge funds need only be restricted to more sophisticated investors like him. In a New York Times op-ed column Wednesday, he opined that regulators should "prohibit unsophisticated players from participating in hedge funds."

But what will that do to solve the problem? In five years, Swensen will just be calling for even higher restrictions placed on exempt accounts. That's like I refer to as the stupidity of building bigger jails to solve these problems.

In my view a hedge fund is no different from a mutual fund. I'll discuss my reasons at a later time. But, generally, I believe that a dollar is a dollar. If an investment product is deemed to be legal, it should be able to attract any dollar, regardless of who holds it.

In this second article, a Standard & Poor's analyst takes exception to Swensen's argument. He correctly points out the need for all owners of capital to do more research when considering investment products that entail more risk. If they can do that themselves, fine. If they need to retain an advisor, I say fine to that too.

But the product itself is either legal or it is not. If it is legal, it needs to be regulated.

Posted by Posted by Bill Cara on October 20, 2005 09:18:43 AM | Category: Cara "Focus" of the Week

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