Crowd flocks to SEC hearing on hedge funds

Date: Thursday, May 15, 2003

By Walter Hamilton:Los Angeles Times- WASHINGTON — The simmering controversy over hedge funds drew an overflow crowd yesterday to a Securities and Exchange Commission (SEC) hearing where industry executives defended the lightly regulated funds as safe for small investors while skeptics said they are risky and need greater government oversight. Hedge funds, a freewheeling species of mutual fund traditionally favored by the super-rich, have become popular among less-affluent investors as the bear market has derailed more-conventional investment strategies. Their ardor has been stoked in part by the aggressive marketing of hedge-fund companies that hope to tap the legions of disaffected investors. But critics worry that individual investors, as they did with technology funds in the late 1990s, may be jumping into investments that they don't understand at precisely the wrong moment. "Hedge funds are unsuitable investments for unsophisticated investors," David Swenson, chief investment officer of Yale University, said at the hearing. "It would be best for the investment world to have high hurdles in place" to keep small investors out of hedge funds. The debate has huge stakes for the financial industry, a fact that was clearly on display yesterday. Dozens of industry officials gathered outside the SEC's headquarters early in the morning, and a line to get into the meeting snaked down the block about two hours before the hearing began at 9 a.m. It was the first of two days of hearings the SEC is holding as it nears completion of a study to determine whether to impose new rules on the lightly regulated industry. "While there are frequent reports of high returns for hedge funds," said SEC Chairman William Donaldson, "there are reports just as frequently that highlight possible areas of concern, such as potential conflicts of interest, questionable marketing techniques, valuation concerns and the market impact of hedge-fund strategies." Potential rules include forcing hedge funds to disclose more about their operations and imposing stricter limits on who can invest in the funds. Hedge funds make aggressive bets in volatile financial markets, often trying to goose returns with heavy leverage and risky maneuvers such as selling short, or trying to gain from a drop in stocks or other assets. Hedge funds also have largely avoided the "catastrophic" losses suffered by stock mutual funds in recent years, said Robert Schulman, co-chief executive of Tremont Advisers, a fund consulting company. Industry experts also stressed that the funds are increasingly pitching themselves to institutional investors such as pension funds and endowments rather than small investors. But regulators pointed out that some funds have aggressively pitched themselves to individuals while downplaying the risks. Some of the marketing is "pretty over-the-top," R. Clark Hooper, senior vice president at the NASD, formerly the National Association of Securities Dealers, said during a break. Paul Roye, the head of the SEC's investment-management division, said during a break that one fund company is seeking permission to list its shares on a stock exchange, while others have applied to be open-end mutual funds — both steps that would make them available to small investors. When hedge funds were the preserve of the wealthy, the lack of oversight wasn't a concern because regulators figured that well-to-do investors could watch out for themselves. One reason that hedge funds are now accessible to the less affluent is that mandatory income and net-worth standards needed to invest in a hedge fund have not been boosted in years. An investor must have at least $1 million, including real estate; or an annual salary of $200,000 ($300,000 for a couple). As home values have shot up in recent years, that has made the funds available to more investors. Hedge funds have a reputation for operating in secret, thus making it impossible to discover problems before a fund explodes. That has happened several times in recent years. Copyright © 2003 The Seattle Times Company