Amaranth debacle raises cry for regulation
More restrictions on hedge funds are needed after one fund's big losses, some critics say.
NEW YORK (CNNMoney.com) -- Hedge fund regulation is once again a hot topic in the wake of Amaranth Advisors LLC's warning Monday of significant losses due to a bad bet on the natural gas market.
In a research note Wednesday, Punk & Ziegel analyst Dick Bove said there is speculation that Congress may now take a closer look at the industry and move to place more restrictions on its activities.
Indeed Tuesday, Connecticut Attorney General Richard Blumenthal said he was gathering evidence and reviewing facts concerning reported losses of $3 billion to $5 billion at Amaranth, a Greenwich, Conn.-based hedge fund. He also renewed his call for greater disclosure by the industry.
"Particularly problematic are alleged representations made to investors in recent weeks by the management of Amaranth that may be contrary to apparent facts," Blumenthal said in a statement. "Such claims - if made - would contradict the spirit and letter of current law. The facts about mammoth losses by Amaranth offer additional powerful and compelling evidence about the need to reform disclosure and oversight requirements."
Tougher rules coming?
Amaranth may be a catalyst for more regulatory oversight because the company exposed pensions funds to its losses, said Scott Meyers, chair of the litigation practice group at Chicago-based law firm Levenfeld Pearlstein.
"Before hedge funds were the province of the super wealthy and there was feeling that they can protect themselves," Meyers said. "Now you have a number of pension funds involved [in the hedge fund industry] and that will be hitting regular Americans in the pocketbook."
Meyers said those are the type of people the government will seek to protect by bringing hedge funds under the regulatory umbrella.
Also on Tuesday, Securities and Exchange Commission Chairman Christopher Cox said the problems at Amaranth are a reminder of the risks of some hedge fund investing, according to Reuters
"It may be a bit too early to infer all the potential lessons to be be learned from what's happened this week. But it is certainly a reminder that investing in certain kinds of hedge funds is risky business and it's not for mom and pop," Cox told reporters after a congressional hearing.
The hedge fund industry - which caters to wealthy clients and institutional investors - historically has been a highly secretive community.
Hedge funds use a variety of strategies, from betting on or against stocks, currencies or commodities to more esoteric strategies involving derivatives like futures and credit default swaps. Estimates of the size of the hedge fund industry vary, but one widely used figure is $1.225 trillion, according to Hedge Fund Research in Chicago.
Meyers said pension funds in particular aren't shy of being litigious when faced with large-scale financial losses. If Amaranth is shown to have been over concentrated in the natural gas arena - although the fund presented itself as a multi-strategy fund - that could be considered inconsistent with its business philosophy and may open the door for some civil litigation, he added.
But he said liability for the firm would largely be determined by how much the fund's CEO and managers knew and how much they disclosed to its investors.
And its that lack of disclosure within the hedge fund industry that is particularly inflaming critics.
"As SEC Chairman Christopher Cox said yesterday, these developments tend to indicate that investing in hedge funds can be more risky than many perceive," said Ross A. Albert, securities partner at Atlanta-based Morris Manning & Martin. "Funds have increasingly been accepting money from smaller, less sophisticated investors who may not be able to fully appreciate the risks and may be less able to withstand a total loss."
Hedge fund industry still strong
Despite criticism, Punk & Ziegel's Bove said the hedge fund industry has proved itself to be fundamentally sound and its unlikely that the fervor surrounding Amaranth will lead to any major regulatory shifts.
Bove said that Amaranth's losses of about $5 billion in one week don't appear to be a systemic problem.
"An over confident trader, under lax supervision, lost billions of dollars," he said. "There does not appear to be any likelihood of a 1998 meltdown similar to the one caused by Long Term Management."
But the specter of Long Term Management - which imploded and caused a number of securities to tumble in its wake - continues to haunt the industry and has kept regulators busy in an attempt to reign in some of the hedge fund industry's relative freedom.
The industry has dodged a number of attempts by regulators to put more restrictions on hedge fund activities and disclosures in recent months.
In late July, the U.S. Court of Appeals for the D.C. circuit threw out the SEC's hedge fund registration rule, which took effect in February after years of intense debate. The rule required hedge funds to register with the SEC as investment advisers and submit to occasional inspections of their books and records.
But the SEC is expected to develop emergency rules to reinstate other aspects of the rejected rule.
Meyers said he was surprised that the SEC didn't appeal the ruling.
"It suggest to me that they have other options that are superior to the expense and risk of filing an appeal," Meyers said. "They may have some support in Congress to try to fix this - a non-judicial solution that will get a bigger result."
While Bove expects any regulation that comes out in the wake of the Amaranth debacle to be fairly minimal, he said the hedge fund industry which has outperformed the market in recent years, may finally be slowing down.
"The hedge funds are now moving in to a second less profitable stage of growth," he predicted.