CHANGING THE RULES TO SAFEGUARD HEDGE FUNDS
By BETH PISKORA
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Regulators may have been sleeping on the job when the first hedge fund crisis broke, but are taking steps now to ensure they don't drift off again.
In the United States, where disclosure laws are the strongest, regulators are studying the books at numerous Wall Street firms to determine how much trading with and loans to risky hedge funds threatened financial market stability.
The stepped-up level of investigation comes after one hedge fund, Long-Term Capital Management, had to be bailed out to the tune of $3.6 billion in September.
The only alternative to the bailout, in which 12 Wall Street firms paid up to $350 million each to take over 90 percent of the fund, was the fund filing for bankruptcy protection, which the Fed feared would disrupt already-troubled world markets.
The fund, run by disgraced former Salomon Brothers executive John Meriwether, was highly leveraged, investing $50 for every $1 in capital it had.
If Meriwether were forced to sell off his losers in a quick liquidation, other investors would have seen the value of their holdings drop precipitiously.
But at least one regulator knew of Long-Term Capital's pending troubles months before the bailout. According to published reports, Brooksley Born, chairwoman of the Commodity Futures Trading Commission, failed to act on her knowledge of the fund's highly-leveraged status, even though she knew of it months earlier.
Under current U.S. law, Born could not share that information with other regulators, including the Federal Reserve and the Securities and Exchange Commission, unless those authorities requested the information.
A group of U.S. and international regulators, led by SEC Chairman Arthur Levitt, met on Friday to discuss a change in the rules that, if in effect this past summer, would have allowed Born to share the dismaying debt details.
"Our experience proves that reliable disclosure, transparency, and effective regulation are the essential ingredients for strong markets," said Levitt.
"I'm not sure the response to the problem of Long-Term Capital should be regulation," Levitt added. "I expect that the tack we will take will be increased disclosure."
However, Levitt may not get the support of international regulators in his quest. The Bank of England, the British equivalent of the U.S. Federal Reserve, said in a report that tighter regulation of hedge funds could prove self-defeating. The report urged hedge funds to regulate themselves.
Since most hedge funds are headquartered outside the United States, U.S. regulators have little control over what the funds can or cannot do. U.S. regulators can only work to protect banks and brokerages under their jurisdiction from taking on too much hedge fund-related risk.
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