Hedge Funds on Hot Seat

Date: Monday, November 10, 2008
Author: Jenny Strasburg, WSJ.com

Top Managers to Go Before Congressional Panel.

It is hedge funds' turn on Capitol Hill.

The congressional committee that made headlines last month grilling former Lehman Brothers Holdings Inc. Chief Executive Richard Fuld and former executives of American International Group Inc. has summoned a handful of top hedge-fund managers to answer questions on topics ranging from their pay to influence on the markets.

Philip Falcone, Kenneth Griffin, John Paulson, James Simons and George Soros on Thursday are expected go before the House Committee on Oversight and Government Reform. They will have several minutes each to make opening remarks, then will field questions from lawmakers, according to a committee spokeswoman.

For these executives, who have been tapped to speak for the industry, it probably won't be an entirely pleasant experience. "We've been under fire for a while," said Richard Baker, head of the U.S. hedge-fund industry's biggest lobbying group, the Managed Funds Association, in Washington. The firms represented at this week's hearing belong to the association.

"Hedge funds are a fairly easy political target. They're looked upon as high-net-worth people doing things we don't necessarily understand," Mr. Baker said. Most hedge funds are suffering along with other investors, though the funds' average declines haven't been as steep as those of the major market indexes.

The investors appearing this week each earned more than $1 billion last year, based on their funds' performance and estimated fees from clients.

The committee plans to ask the executives whether their firms, which are some of the most powerful in the business, and others like them pose systemic risks to the markets because of big trades and the vast sums of money they borrow from banks.

Mr. Baker and others say hedge funds aren't responsible for the failure of Wall Street institutions and the loose home-lending standards that helped create the financial crisis. But these managers likely will face suggestions that they and their hedge-fund peers contributed to problems, or at least profited amid the troubles of millions of Americans.

Already, momentum is building to monitor hedge-fund activities more closely and curtail some trading activities, through greater regulatory oversight and lower borrowing limits, industry insiders said. Recently, hedge-fund managers lost loopholes in the federal tax law that allowed them to postpone for years paying taxes on certain profits. At the same time, hedge funds were crippled in September by temporary limits on their ability to bet against hundreds of financial stocks, or short selling, in what was seen as an ineffective effort to protect those stocks from declines.

The funds also face new rules on how they value hard-to-sell assets.

Regardless of how long economic troubles persist, Congress may seek in the next year to require all hedge funds above a certain size -- say, with $25 million or more in assets -- to register with federal regulators. Registration means regularly scheduled examinations and more government oversight of risk controls and behavior in stock, debt and derivatives markets. Right now, registration is voluntary.

"Large hedge funds are expecting increased regulation, probably more in line with the closer regulation of broker dealers," said Leor Landa, a partner at law firm Davis Polk & Wardwell who represents hedge funds and private-equity firms.

Meanwhile, the Managed Funds Association and other organizations representing hedge funds are spending record amounts lobbying, according to industry insiders. Having five of the best-known and wealthiest investment managers together publicly before Congress is unprecedented for the roughly $1.8 trillion hedge-fund industry, which has been losing assets as investors withdraw money and has seen assets shrink in value amid market turbulence.

Given the outlook for the economy and continued market woes, hedge-fund managers could be called to Washington again soon. "I suspect my industry will be brought before the Congress in the next 12 to 18 months with some regularity," said Mr. Baker, a former Louisiana congressman.

Write to Jenny Strasburg at jenny.strasburg@wsj.com