Hedge funds get House warning

The Baltimore Sun

WASHINGTON -- Members of Congress had a message of caution yesterday for the booming, unregulated hedge fund industry: Proceed with care, because lawmakers are increasingly willing to clamp down to ensure discipline in the marketplace.

"I don't think anybody can be confident that all's entirely well here," said Rep. Barney Frank, the Massachusetts Democrat who is chairs the House Committee on Financial Services. "It's a matter of concern."

Frank later told reporters he may introduce legislation later this year that would require hedge funds to save various documents, such as trade records and e-mail, which could be of potential use to law-enforcement officials in cases of fraud.

Also yesterday, the Securities and Exchange Commission approved a rule affirming its ability to sue hedge funds for fraud.

The SEC action follows legal rulings that tossed out a previous SEC rule requiring hedge 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," said SEC Chairman Christopher Cox.

The developments underscored growing jitters that private investment pools such as hedge funds could spread instability throughout the financial markets.

Lawmakers noted the 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 as warning signs.

Hedge funds utilize an array of trading techniques to pursue lucrative returns, sometimes shifting strategies with dizzying speed and often using debt to enhance the payoff. By some estimates, they are now worth $2 trillion.

In February, the President's Working Group on Financial Markets contended that "market discipline" would be the most effective form of oversight 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" on the most effective ways to limit and manage risks, said Kevin M. Warsh, a Federal Reserve governor.

But many in Congress remain doubtful, and members made their feelings known to officials from the Federal Reserve, Treasury, SEC and the Commodity Futures Trading Commission.

Lawmakers pointed out that the meltdowns of Amaranth Advisors and Bear Stearns funds occurred against the backdrop of a healthy financial system. In different ways, they asked: What would happen if such problems unfolded at a time of greater financial instability?

"We hope self-regulation can be the order of the day," said Democratic Rep. Paul E. Kanjorski of Pennsylvania. "If it fails, the Congress will be called upon to move in very swiftly and very deeply."

Pension funds that are increasingly invested in hedge funds are among lawmakers' concerns. The prime example is an episode involving the San Diego County Employees Retirement Association, which invested $175 million in the Amaranth Advisors hedge fund that later collapsed. The retirement association has accused Amaranth of deception and brought suit.

While recent turmoil has prompted calls for greater oversight, some expressed doubts yesterday. 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 better 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 of Alabama, the senior Republican on the financial services panel.

Jonathan Peterson writes for the Los Angeles Times.

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