Alternative investment professionals don't often attend meetings where just about anybody can show up. But there they were – four hedge fund managers, along with three additional witnesses, seated elbow to elbow in front of the US House Financial Services Committee. Also in the committee room were congressional staff members, cameramen, federal bureaucrats, and anyone else who made it past security at the Rayburn House Office Building, including a private equity journalist curious to hear the question US lawmakers have for managers of private investment pools.
The committee is chaired by Barney Frank, a democrat from Massachusetts and a congressional veteran who, according to someone who has closely followed his inquiry into the matter, is making a serious effort to understand the so-called hedge fund industry before suggesting potential legislation, if any. Frank, who is gruff-voiced and somewhat curmudgeonly, injected an admirable amount of levity into a hearing titled “Hedge Funds and Systemic Risk in the Financial Markets”.
The meeting was somewhat of a prelude to a planned hearing on private equity before the same committee. Frank's office has not released further details, other than to announce its intention to learn more about this industry.
A long-time Washington lobbyist told me that one can gain insight into a congressional committee's initial view on a topic by scrutinising the make-up of a hearing witness list. In the case of last month's hedge fund hearing, it appeared that Frank was not interested in organising a sparing match between hedge fund proponents and detractors. Instead, seated before the committee were senior partners from hedge funds Taconic Capital, Kynikos Associates, Clinton Group and Ram Partners.
Also on the list were Gerald Corrigan, a Goldman Sachs managing director and former Federal Reserve Bank president, Andrew Golden of the Princeton University endowment and Professor Stephen Brown from New York University's Stern School of Business. Absent was anyone who thought that hedge funds posed a grave danger to the financial system. Only Kenneth Brody of Taconic said he thought it was a good idea for hedge funds to register with the SEC.
In general, the committee members were well aware of the deficiency of the term “hedge fund” in describing a vast set of activities. Several, including Alabama republican Spencer Bachus and Connecticut republican Christopher Shays, made clear their skepticism that hedge funds needed any oversight whatsoever. But the witnesses were peppered with a recurring question – what about the public pensions that are increasingly investing in hedge funds? Did the average pensioner understand, for example, the risks his capital was exposed to when his pension fund backed Amaranth Advisors, the $10 billion hedge fund that collapsed last year following bad bets on natural gas?
More than one witness responded that pensioners, and investors of all stripes, had lost far more due to the collapse of ordinary stocks than at the hands of bad hedge fund managers.
Addressing a comment from a committee member that hedge funds are secretive, two witnesses brought up Regulation D's general solicitation prohibitions. If private investment franchises seem mysterious, they argued, it is partly to do with the fact that the SEC restricts principals on what they can say about their operations publicly.
Goldman Sachs' Corrigan, however, expressed skepticism that public disclosure will accomplish much for private investment firms. Far more important, he said, are three forms of disclosure at which hedge funds and other private pools of capital already excel – highly detailed disclosure counterparties such as prime brokers, disclosure to investors, and disclosure to regulators when requested.
Public disclosure, said Corrigan – even something as mild as registering with the SEC – can create a moral hazard. It gives the impression to some that the government is vouching for the safety of a set of funds, where no such safety can possibly be determined.
There was another recurring theme – several congressmen and witnesses alike noted that one couldn't discuss “hedge funds” without also including the many other forms of private investment pools, including private equity and venture capital.
Pay close attention to the witnesses called when private equity goes to congress. If the list includes, say, GPs and couple of sympathetic LPs, the prognosis is good. If it's two GPs, two angry union leaders, Michael Moore and an economist predicting an American economy drowning in a sea of bad corporate debt, expect an uphill battle.