Bill Ackman Talks Financial Regulation & Ratings Agencies

We wanted to quickly highlight that BloombergTV recently had Bill Ackman of hedge fund Pershing Square on to talk about financial regulation and the ratings agencies. The conversation stems from Ackman's battle with MBIA where he shorted the stock and over the course of six years eventually won. This story is detailed in Christine Richard's new book Confidence Game that we recently reviewed. In order to help change the system, Ackman is in favor of Sheila Blair's proposal which he talks about in the interview.

Embedded below is the video and Email readers will need to come to the site to view it:



For more of our coverage on Bill Ackman, be sure to check out our recently updated post on Pershing Square's portfolio.

Hedge Fund Compliance & Regulation Podcast

Hedge fund compliance is a growing topic these days and we've stumbled upon an interesting informational podcast for those interested. Kelly Moll, a partner at Schulte, Roth and Zabel, specializes in advising on registration and compliance issues. She has teamed up with IntraLinks to create a podcast series on the subject. Their first installment just became available and we've embedded the transcript below. The first episode is entitled, "What you need to know about U.S. and EU proposed legislation: New regulation requirements and assessing systemic risk."

Given all the recent scandals and ponzi schemes, further hedge fund regulation seems inevitable. Various proposals in both the United States and European Union address various requirements for fund manager communication to regulators, counterparties, and investors. Establishing transparency between hedge funds and their investors is key given that trust is essential in this relationship now more than ever due to all the fraudulent schemes that have surfaced. The podcast below helps to breakdown the proposed regulations and how a hedge fund firm can prepare for these possible new requirements.




You can listen to the podcast here or download the .pdf transcript here.

The Future Of Hedge Fund Regulation

Just yesterday, we had an intriguing guest post regarding the future of hedge funds. Today, we follow it up with another excellent guest post examining the future regulation of the hedge fund industry. The following is a guest post from Hedge Fund Blog Man, who covers articles of note regarding the hedge fund industry.

"
The Future of Hedge Fund Regulation in the United States

Summary
Over the last couple of years there has been a lot of political discourse about the need for greater regulation of the financial industry, including hedge funds. Much of the information (and rumors) about possible hedge fund regulation is somewhat contradictory. We will wade through the debate and provide a summary of current proposals for hedge fund regulation in the US and discuss hedge fund regulation in the EU and other countries.

Though it was highly regulated financial institutions that are widely believed to be the cause of the recent financial crisis and subsequent economic malaise, there is talk of regulating hedge funds and private equity firms as well. There have been a huge number of proposals for regulating hedge funds ranging from registration requirements for just the largest to funds, to almost authoritarian regulation for all private money managers. However, the current proposals with the most support appear to be hedge fund registration requirements, without significant additional oversight.

Current Hedge Fund Regulations
Under the existing system hedge funds and private equity firms are far less regulated than mutual funds and other investment vehicles open to the public. Though some hedge funds are registered with the SEC, a couple clauses in the Investment Company Act of 1940 allow must hedge funds to operate without registering with the SEC or any other government agency. Probably fewer than half of all hedge funds are currently registered as investment advisors with the SEC. For funds that are registered, the SEC requires certain filings, but does not provide operational oversight.

The Need for Hedge Fund Regulation
Hedge funds were clearly not the major players in the current financial crisis. However, the $50 billion fraud perpetrated by Bernard Madoff sparked plenty of public outrage and there have been a couple of multi billion dollar hedge fund failures since 2007. Additionally, many politicians still fear another hedge fund collapse ala Long Term Capital Management, the giant hedge fund that collapsed in 1998 and necessitated a Federal Reserve orchestrated bailout.

Treasury Secretary Timothy Geithner voiced his concern in April, "Today, the consequences of (hedge funds') failure is greater. They need to be subject to a higher set of standards.”

Proposals for Regulating Hedge Funds and Recent Developments (2009)
In January 2009, Senators Charles Grassley (R-Iowa) and Carl Levin (D-Mich.) introduced the Hedge Fund Transparency Act of 2009. The Act would affect funds with more than $50 million in assets (“large firms”). All funds in excess of $50 million would be required to register with the SEC and maintain books and records according to SEC requirements. It would also require disclosure of including information regarding the identity (including addresses) of the fund’s “beneficial owners,” the amount of the fund’s assets, the fund’s equity structure, affiliations the fund may have with other financial institutions, the minimum investment commitment required of investors, and the total number of investors. The bill did not get to a vote.

In March of 2009, Larry Summers , Director of the National Economic Council for Barack Obama, said the U.S. wants large hedge funds and private-equity firms to be subjected to "rigorous public scrutiny," compared with the minimal oversight they now face. Before joining the Obama Administration, Summers was a Managing Director with one of the worlds largest hedge funds, D.E. Shaw Group.

Then in late April, President Obama lashed out at hedge funds refusing to accept a government offer for Chrysler debt. "A group of investment firms and hedge funds decided to hold out for the prospect of an unjustified taxpayer-funded bailout," Obama said, "They were hoping that everybody else would make sacrifices, and they would have to make none. Some demanded twice the return that other lenders were getting. I don't stand with them."

In July, the Obama Administration, released TG-214, a fact sheet with the Administration’s proposals for regulating hedge funds. Funds with more than $30 million would be required to register with the SEC. Once registered funds would be subject to:
• Substantial regulatory reporting requirements with respect to the assets, leverage, and off-balance sheet exposure of their advised private funds
• Disclosure requirements to investors, creditors, and counterparties of their advised private funds
• Strong conflict-of-interest and anti-fraud prohibitions
• Robust SEC examination and enforcement authority and recordkeeping requirements
• Requirements to establish a comprehensive compliance program
The main rationale for the above requirements is to “protect the financial system from systemic risk”

The most recent House of Representatives proposal for hedge fund regulation, from Aug 6, 2009, seems to have lost some of the initial enthusiasm and would regulate hedge funds under less-stringent conditions than banks and lenders. According to House Financial Services Chairman, Barney Frank, “How can you regulate a hedge fund like a mortgage? It doesn’t make any sense. It will be a form appropriate to them.” In apparent moment of bipartisanship, both Democrats and Republicans seem to be in agreement that hedge fund and private equity firms should be more lightly regulated than other traditional financial firms. It should also be noted that hedge fund industry groups spent almost $4 million in lobbying in the first half of 2009.

Hedge Fund Regulation in Europe
Europe has been quicker to attempt hedge fund regulation and proposals there have generally been more severe than in the US. Likewise, hedge funds and private equity firms in the EU have been more vocal in their opposition to regulation than their US counterparts. The most contentious issue in EU hedge fund regulation appears to be an attempt to limit or place caps on the amount of leverage funds can employ. Because of the possibility of regulatory arbitrage, look for the EU and US to finalize regulations that are relatively consistent.

When Will We Get New Hedge Fund Regulations?
Though there are ongoing talks, there is currently no bill for hedge fund regulation in Congress that is likely to pass. It is unlikely any new regulation will be finalized until 2010. Because compliance with new rules could be costly and time consuming, it is conceivable that new hedge fund regulations might not be enforceable until 2011.

"


Thanks to HFBM for the excellent write-up as we will definitely be watching the developments on this front going forward. Regulation and transparency have been big talking points given the crisis, forced liquidations, frauds like Madoff, and numerous other crazy events that have happened recently. The above was a guest post from Hedge Fund Blog Man, who covers articles of note regarding the hedge fund industry.

Public Disclosure of Short Positions is Probably a Bad Idea

A month or so ago, we saw that some of Obama's aides were pushing for a disclosure of hedge funds' short positions, similar to how funds disclose long positions with 13F filings. And, we thought it would be interesting to consider the pros and cons of such a maneuver.

While we would love this because it would give us even more to blog about in our hedge fund portfolio tracking series, we ultimately feel that it would be bad for the markets. Remember that massive drop-off in the markets back in October and November? Yea, part of the reason for the massive selling in certain equities was funds "front running" each other. When you 'front run,' you are basically shorting the long positions of other struggling funds that you figure they will be forced to sell. Initially, funds were forced to sell positions due to the fact that they were struggling due to weak performance and/or redemption requests. This situation was further amplified when the lions started to attack the wounded wildebeest. At the time, many funds were liquidating and/or seeing a large amount of redemptions.

Once other funds got wind of who the weak were, they went to feast. 'Only the strongest will survive.' By merely pulling up a 13F filing with the SEC or doing some poking around, you could get a general idea as to what some of that fund's largest holdings were... holdings that would typically take a few days to sell out of, if forced to liquidate. And, the front-running began.

Now, imagine a similar scenario where other funds 'front-run' weak funds' short positions. But, here's the difference: Those weak funds could only lose a finite amount of money on their longs they were forced to sell. If/when the stock goes to $0, the cycle is done. However, if a fund is short a stock and they get caught in a squeeze, they can lose an exponential amount of money (as there is no ceiling as to how high a stock can go - as recently illustrated in the Volkswagen short squeeze). So, imagine a weak fund that is short a ton of shares of XYZ company, one of their largest short positions. Everyone gets wind that they are weak and starts buying shares, squeezing the weak fund that is short, and forcing them to cover. After all, it doesn't take very long for a stock to skyrocket. The potential fund losses could be exponentially greater and trigger yet another wave of weak funds being forced to liquidate positions. The main point here is that such a disclosure could lead to even more volatility and even more chaos. There is one caveat with this theoretical scenario though: Its not as easy to figure out their short positions as it is their longs. Funds are required to disclose their long holdings to the public, but not their shorts. And, a fund's short book is often one of their closely guarded secrets. So, if you require public disclosure of such shorts, then other funds can quickly prey on the weak yet again.

This is just one tiny theoretical example, but there are many reasons to oppose this proposition. Throwing yet another wrench in the current system would give many funds pause about how they normally go about structuring their portfolios. Funds would undoubtedly try to find new, complex ways to short without having to disclose it. As we just mentioned, their short positions are often their prized secrets. And, shorting is an essential part of not only many hedge fund strategies, but also market liquidity. Remember the shorting ban? Yea, that worked well. /Sarcasm. While disclosing shorts is obviously not as extreme of a move as eliminating shorting altogether, there would definitely be repurcussions. Additionally, we wonder if disclosing the short positions could possibly have the 'Warren Buffett' effect, but in the opposite direction? Many investors piggyback Buffett's plays and when he discloses a position, the stock usually ramps up and gains more following. So, imagine a scenario where a couple of prominent hedge funds are required to disclose they are massively short XYZ company. You can bet that many people will piggyback that trade and possibly send that stock spiraling downwards. And, this is exactly what has happened in the past. For instance, take David Einhorn of Greenlight Capital. He laid out a short thesis for Allied Capital a couple of years ago at a charity investment conference one night. That next day, while other stocks opened for trading, Allied Capital remained closed because there were so many people trying to short it. Einhorn even wrote about this story and his encounter with Allied in his book, Fooling Some of the People All of the Time. The main point here is that such a disclosure proposition could have many unintended consequences and could possibly do more harm than good.

You can bet that nearly all hedge funds will be opposed to this disclosure if it will be available to the public. Most, however, have no problem revealing the positions in private to regulators. If it is revealed to the public though, that's where many hedge funds take issue. And, many prominent hedge fund managers shared this exact stance when they testified before Congress. And, we feel this is the correct move. By disclosing this information privately to regulators, we can (hopefully) have better risk management. That is, assumming, we have faith in regulators to do their job. Exactly how regulators will use this information, we're not entirely sure. But, we do know one thing: Disclosing such information to the public could potentially open a can of worms.