Paulson Committee Backtracks

After standing firm on limiting (read: doing nothing) hedge fund regulation, the President’s Working Group on Financial Markets has apparently caved under international pressure...well, kind of. The Wall Street Journal reports that though earlier this year the group said current regulations were sufficient to prevent hedge funds from threatening the financial system’s stability, they will create two new advisory groups to develop voluntary "best practices" guidelines for investors in hedge funds and the managers that run them.

Apparently the pressure comes from German Chancellor Angela Merkel and French President Nicolas Sarkozy; neither of whom can be regarded as anti-capitalists. It remains to be seen whether the committee can whitewash their concerns as they have with U.S. investor advocates, given that the response will be to ask (politely I’m sure) hedge fund managers and investors to voluntarily adhere to meaningless guidelines on disclosure and due diligence.

Another issue the two subcommittees will discuss will be valuation, a lightening rod issue on Wall Street. Hedge funds love the mark-to-model method that allows them to use their own fuzzy math to determine the value of their portfolio, and consequently their 20 percent take of the returns. The more acceptable method is the mark-to-market, where a financial instrument’s value is based on the current market price.

When it comes to valuation methods, disclosures and due diligence, voluntary guidelines aren’t enough. Wall Street has been down this road before and it didn’t work. Stock analysts were supposed to adhere to best practices and we all know how that story ended. Already major hedge fund blow-ups have occurred, most notably at Bear Stearns which faces litigation, including several claims filed by Zamansky & Associates on behalf of investors. This trend is sure to continue so long as Wall Street is allowed to make up its own rules.

“Our Clients Interest Come First” – Goldman Sach’s tagline

Goldman Sach’s tagline comes to mind while coming across a story in Friday’s Financial Times (subscription required). Apparently, the white shoe investment bank raked in some $300 million in profits from the $2 billion it injected into its failing Global Alpha and GEO hedge funds along with several partners including Hank Greenberg, who was just interviewed by the SEC concerning his involvement in possible wrongdoing at A.I.G. On the other hand, the investors in the hedge fund are still reeling from losing 23% of their original investment.

This situation truly is an example of “Wall Street versus America,” which is also the title of a highly recommended book written by Gary Weiss, a former investigative reporter at BusinessWeek and prominent blogger. Gary’s book dedicates several chapters on hedge funds and opens chapter nine with the following passage:

It happens when you least expect it. You may be at an alumni reunion where people are drinking too much, or perhaps you are at a party that you know you should have skipped. A “financial consultant” or “advisor” sidles up to you near the munchies, asks a few innocent-sounding questions, and purrs gently, “So…that means you are an accredited investor! Now I have at my office a numbered offering memorandum I can send right over to you for the Millennium Partners Variable-Interest Market Neutral Alpha Partners Partnership III.”

If anyone ever says that to you, take the nearest crudités and eject them firmly in the direction of the offending words. If bodily injury results – well, any jury would call it self-defense.
Hyperbole aside, Weiss’ book is actually a balanced look at alternative investment strategies and I wrote a review of it for the Daily Deal here. But whatever the advantages or disadvantages to investing in hedge funds, they are in the business to make money for themselves - first and foremost. You, the investor, are only a means to that end.

And, above all else, hedge funds fiercely guard their privacy when it comes to investment strategy. Investors in Goldman’s hedge fund likely did not have access to the minutia of the Global Alpha and GEO funds’ strategy, so they probably didn’t have any way to effectively gauge whether to pull their money out or leave it in the fund. Goldman Sachs likely did and saw an opportunity. Careful to share the risk when it comes to their own proprietary investments, Goldman was even generous enough to share it with billionaire Wall Street friends.

Low and behold the timing was brilliant and they all made money while investors on the outside are left wishing they bought into Goldman Sachs’ shares and not its hedge fund. Just another case of “Wall Street versus America.”

Dirty Laundry Stowed…For Now

As I posted before, Governor Spitzer was between a rock and a hard place when it came to Darren Dopp, his aide that was placed on “indefinite” leave after the Trooper Gate story broke. Spitzer could either run Dopp off the reservation and risk him airing the Gov’s dirty laundry or hire him back and face a severe credibility question. As it turns out, the dirty laundry was scary enough to warrant rehiring Dopp, likely near his old salary of $175,000 per year.

If you flash back to August 3rd, Dopp’s lawyer did some clever public relations work and made sure reporters included in their stories that Dopp felt he was being scapegoated for the scandal and is willing to testify.

“What happened to Darren is just not fair,” said Dopp’s lawyer. “Darren is getting screwed.”

No sir. The people of New York are.