A shadow over hedge funds

Date: Monday, January 22, 2007
Author: International Herald Trubune

A truism of investing is that to beat the market consistently, an investor must either take above-average risk or trade on inside information. That inevitably casts a cloud over hedge funds, which exist to beat the market. Many fail, sometimes spectacularly so. But many succeed. The question is, How?

The Wall Street Journal has reported that Eliot Spitzer was asking just that question. Shortly before he resigned as New York's attorney general to become governor, Spitzer opened investigations into whether employees at companies including Best Buy and Circuit City had improperly given nonpublic information to hedge fund managers.

Two research firms, the Gerson Lehrman Group and Vista Research, a unit of McGraw Hill, are also under investigation. They specialize in matching up people who have information — say, middle managers — with clients who crave information. The firms collect fees from hedge fund clients and pay sources as consultants. Business for these firms has boomed since 2000, when federal regulators enacted disclosure rules that made executives at public companies wary of speaking privately with big investors.

It will be up to the prosecutors to determine if the matchmaking firms merely appear to be conduits for nonpublic information, or if they indeed are. The firms say they follow procedures to guard against any inappropriate disclosures.

But the safeguards seem weak. The new Congress should move forward with hedge fund regulation. The possibility of a destabilizing meltdown only grows the longer the funds escape oversight.