Outsource the SEC, for Hedge Fund Exams and Systemic Risk |
Date: Thursday, April 23, 2009
Author: RiskCenter
Hennessee Group LLC, consultant and adviser to direct investors in hedge
funds, re-released a summary of recommendations to reduce fraud and systemic
risk in the hedge fund industry. Charles Gradante, co–founder of Hennessee
Group, recommends that Congress, the Securities and Exchange Commission, and the
Federal Reserve Bank consider the following summary of recommendations that Mr.
Gradante has made over the years since 1998 to the House of Representatives, the
Senate Banking Committee, the Securities and Exchange Commission, and the
Commodities Futures Trading Commission. Fraud Risk “For obvious reasons, outsource hedge fund fraud audits to third parties,
such as Kroll,” states Mr. Gradante. “They have the forensic
skills and ‘street smarts’. Have Limited Partners select the company to perform
the fraud audit and have that company issue a ‘Fraud Audit Report Card’
to limited partners and the SEC.” Systemic Risk Gradante strongly agrees with President Obama that “regulation can reduce
systemic risk”. Gradante adds “I believe the President wants regulation that
is proactive not reactive.” “Assign the equivalent of a CUSIP Number to each hedge fund
(especially the top 100 in assets which constitute the vast majority of
systemic risk potential). Monitor leverage extended by commercial banks and
prime brokers using the CUSIP Number concept,” states Mr. Gradante. As an ex-CEO of a U.S. National Bank, Mr. Gradante commented that “the ‘Know
Your Customer Rule’ is fundamental to lending. This rule has been distorted
by many banks and prime brokers, with respect to hedge funds, resulting in a
greater potential for systemic risk (i.e., Long-Term Capital Management).”
Gradante concluded, “No balance sheet… no extension of credit.” (See Mr. Gradante’s October 1998 Testimony on Long-Term
Capital Management below). Gatekeepers The “Gradante Gatekeeper Concept” simply states that all
gatekeepers should have a vested interest in ensuring the integrity of the
hedge fund industry for investors. It should be mandated that gatekeepers are
accountable and responsible as follows: Policy Changes “The following policy changes should be mandated” stated Mr. Gradante. - Banks and Insurance companies should not be allowed to “over insure”
a bond issuance. For example, sell $10 billion of CDS insurance paper on a
$2 billion bond issuance. This practice has (in part) intensified the “crisis
of confidence” in the financial services industry. No one knows who
is holding “the old maid”. - Credit Default Swaps are insurance contracts, and
should not be treated as put options. Credit Default Swaps should be
regulated as insurance contracts. - Establish a clearing house for CDS market and monitor
counterparty risks. Sources: 1 Multiple Prime Brokers will require a more complicated
technique. Testimonies (October 1998) Mr. Gradante's Testimony on Long-Term Capital
Management to The Committee on Banking and Financial Services: House of
Representatives, (See page 5-7)
http://hennesseegroup.com/information/info/TESTIMONY%20OF%20CHARLES%20GRADANTE%20OCTOBER%201998.pdf (May 14 – 15, 2003) Mr. Gradante's Testimony to Securities
and Exchange Commission Roundtable on Hedge Funds, (See page 15-16)
http://hennesseegroup.com/information/info/Hennessee%20Group%20SEC%20Submission%20White%20Paper.pdf (July 15, 2004) Mr. Gradante's Testimony to Committee on
Banking, Housing, and Urban Affairs: United States Senate on Regulation of Hedge Fund Industry,
(See page 7-9, 14)
http://hennesseegroup.com/information/info/HENNESSEE%20SUBMISSION%20TO%20BANKING%20COMMITTEE%20with%20CG%20verbal%20testimony-7-15-04.pdf (April 6, 2005) Mr. Gradante's Testimony to U.S.
Commodities Futures Trading Commission: CPO and Commodity Pool Roundtable, (See page 12-13)
http://hennesseegroup.com/information/info/HENNESSEE%20SUBMISSION%20TO%20CFTC%204-6-05.pdf TV Interviews November 2, 2006 Street Signs with Erin Burnett “CDS:
The Undiscovered Elephant in the Room” - Link: http://www.youtube.com/watch?v=jHLDvYZM1i8 - “No one knows who is long or short CDS, who is hedged or
making directional bets.” - “On a scale of 1-10, this is an 8 – 9 problem.” - “There may be a problem with banks that have taken a
concentrated bet against credit spreads widening by selling credit default swaps. Counterparty risk
exists.” November 15, 2006 Bloomberg with Monica Bertran
“Sellers of CDS Will Take Losses Mark-to-Market” - Link: http://www.youtube.com/watch?v=2UkfFbndiL0 - “There are problems in the Credit Default Swap market.
Spreads will widen, causing sellers of CDS to take a hit in Mark-to-Market. A rapid widening of
spreads would cause shock to market.” - “Gatekeeper Concept: Accountants should divulge counterparty
risk in audits; lawyers should do background checks; banks and prime brokers should report
leverage to Fed/SEC; and monthly NAV calculations by administrators to reduce fraud.” Page 4 of 5 Sources (continued): TV Interviews (continued) December 12, 2006 Bloomberg with Monica Bertran “Need
to Do More than Raise Hedge Fund Limits” - Link: http://www.youtube.com/watch?v=2w21p9bRItA - “SEC/Fed should be working with Prime Brokers on monitoring
leverage.” - “SEC/Fed should increase margin requirements on futures
contracts.” - “SEC needs to raise “Net Worth” requirements for hedge fund
investors.” - “SEC/Fed needs to work with Prime Brokers on systemic risk.” March 13, 2007 Bloomberg with Monica Bertran “Subprime
Concerns” - Link: http://www.youtube.com/watch?v=djJ4ErLhDK0 - “Subprime CDO are potential Achilles heel of market.” August 14, 2007 Bloomberg with Brian Sullivan “Hedge
Fund Redemptions” - Link: http://www.youtube.com/watch?v=93N8kGD6Yz8 - “Hedge funds are long credit default swaps.” - “Deleveraging problem is not going away. It will continue
for years.” January 18, 2008 Bloomberg with Brian Sullivan
“Technical Analysis of Stock Market and CDS Trouble for Banks” - Link: http://www.youtube.com/watch?v=kl_6lpDttLw - “Next big shoe to drop is CDS.” - “Banks in trouble with CDS issuance.” December 15, 2008 Bloomberg with Matt Miller “Bernie
Madoff Scandal” - Link: http://www.youtube.com/watch?v=i97_LTemvUU - “Three things the industry needs to do:” �� “Mandate fraud audits by third party such as Kroll.” �� “Monthly NAV for onshore funds.” �� “Accountants to be voted by Limited Partners not manager.” Legal Cases Securities and Exchange Commission vs. House Asset Management - Manager made false statements about his background in
offering memorandum. Securities and Exchange Commission vs. Manhattan Capital - Manager created false account statements which were mailed
to investors by manager. Securities and Exchange Commission vs. Edward Stafaci (Lipper
Convertibles, L.P.) - The Auditors acceptance of “trader marks” for several years
led to sizable losses.
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