Last year was among the worst ever in the history of hedge funds, with $210 billion in losses during the third quarter alone, 693 funds closed through Sept. 30 and an average 16% decline through November. To bolster its scuffed image, the hedge fund industry next month will start leveraging the lobbying skills of Richard H. Baker, 60, a former congressman who represented the 6th District in Louisiana and who took over as head of the Managed Funds Association in Washington a year ago.
All former congressmen are subject to a 12-month prohibition against lobbying members of Congress, and his is set to expire Feb. 2. The MFA's president and chief executive, Mr. Baker will represent a newly proactive effort by the industry to help regulators better understand hedge funds. He plans to spend a lot of time working with lawmakers and regulators to try to bring the $1.6 trillion alternative-class industry out from the shadows.
Q. Where does the hedge fund industry go from here?
A. Investors will exercise appropriate but higher levels of scrutiny before making investment decisions. I think the levels of disclosure required by investors will be enhanced. Hedge funds will certainly be sensitive to their counterparties' credit circumstance. As the unfortunate Lehman Brothers [Holdings Inc. of New York] matter unfolded, there were many people surprised to find their collateral or assets seized in the process.
All of these factors will cause everybody doing business with hedge funds, and those with whom a hedge fund relies on to perform, to exercise higher levels of scrutiny and examination before moving forward. And that means things will move slowly. So recovery will not be rapid, but it will be certain.
Those who have come out of this period with only modest downturns will obviously return to financial health much more quickly than those who have become significantly impaired and could be subject to merger or acquisition.
Q. What do you say to those who claim that short selling by hedge funds played a significant role in contributing to the financial crisis?
A. I have not seen any evidence of that. In fact, the remedies imposed by regulators here and in England have now come to the conclusion that the prohibition on short sales not only did not work but took significant liquidity and disclosure out of the market at the exact time when it was needed.
In the convertible-securities market, someone seeking capital could go to a hedge fund to get a loan. As collateral, the borrower could offer stock to be held by the hedge fund. In order to make sure the value of repayment does not deteriorate because the stock price might go down, the hedge fund manager could engage in a short position against the stock.
If the stock did deteriorate, the short position would offset the loss. We found that many of the shorts on bank stocks were done to hedge positions against credit extended to banks that needed that liquidity.
Q. Did regulators fully understand the impact of introducing a ban on short selling?
A. I think there were a series of emotional decisions made. It started with decisions made in the United Kingdom, where they first clamped down on the shorting methodologies, and I think that led the United States to react.
In most cases, the U.S. Securities and Exchange Commission is a very consultative agency and would bring the affected parties of regulations in for prior comment and discussion about what would happen if we did such and such.
Not that they have to follow the industry's recommendations, but at least they [should] ask our opinions. In this case, at least from an MFA position, not only was there not consultation, we read the order the same time anybody else read it. We were taken aback by it, and we believe now there is considerable academic and regulatory study out there to indicate that it had no effect on the stocks that were identified.
Q. On Feb. 2 when your 12-month prohibition on lobbying members of Congress expires, will that become your full-time responsibility?
A. It will certainly take up a considerable amount of my time. I do fully expect to be before committees of the House of Representative and Senate with some degree of frequency.
I will be with our government relations staff on the Hill a lot visiting members as I am allowed to do so.
This is no longer an organization that is ignored, and we have a responsibility to make sure that this important sector of the financial market is appropriately understood as regulatory decisions are being made.
Q. On what specific areas do you plan to focus?
A. The whole organization has changed its scope and mission as the industry has changed its scope. For many years, this was a sleepy corner of the financial marketplace, where a few people invested with sophisticated people who have significant resources and nobody really cared whether they made or lost money, or whether they went bankrupt. As the industry expanded with more funds and much larger funds, they are no longer a minor component of the modern financial marketplace.
In any upheaval like this, where you have a sector of any market that is not fully understood, which has not engaged in congressional policymaking activities before, there's a lot of misunderstanding about us. So I fully intend to be available to any member of Congress at any time.
Q. How would you characterize Congress' understanding of the hedge fund industry?
A. I have to say, without regard to Congress, that most people don't have any understanding of what hedge funds really do, and the scope of their operations, and so we have a big job ahead of us.
As a result of misunderstanding, even among a lot of journalists, we get characterized improperly. Unfortunately, you say "hedge fund," and people conjure up all sorts of bad things. We've been thrown in the Madoff bucket, and he wasn't even a hedge fund manager.
Q. Are you suggesting that hedge funds have a public relations problem?
A. I think we certainly have an education problem. Speaking for the members of the MFA, not the entire hedge fund industry, we need to improve those relationships in an educational sense.
Q. Do you think attempts to regulate the hedge fund industry further are justified or necessary?
A. I always start those conversations by asking, "What is the concern they are trying to fix?" I think that is a very relevant question. [When people say] registration is the key, I point out that about 70% of the MFA membership is registered, voluntarily. So what is your issue? What is it you're trying to fix?
Q. Do you see any area where the hedge fund industry could be improved through increased regulation?
A. When the President's Working Group [on Financial Markets] came out with their recommendations last year, we immediately began as an organization incorporating all the recommendations into our own sound-practices document. We are not quite finished with it, but we hope to have that concluded by the end of January.
This is the leadership of the regulatory world telling us, "Here are things we think you could address to make you more transparent and provide investors with the disclosures they need."
Q. Is greater disclosure and transparency specifically what the industry is supporting?
A. The best practices are the first step. That should be seen as a continual work in progress. We will continue to work on it and update it as market developments change. We're not quite ready to say the specifics of what we would support, but we're very advanced in our discussions.
Q. Do you anticipate that the Obama administration will push for increased oversight of the hedge fund industry?
A. We've had several discussions with the transition team already. We've had several discussions about the nature of regulation and what it is we do.
I think it's a very healthy signal that the Obama transition team is talking to us. Sure, I think the new president and his team will be involved, but being the old Congress guy, I know that these initiatives start in a congressional committee, and they ultimately get passed in a congressional committee.
We'll spend a lot of time on the Hill discussing all the concerns that members may have, and we hope to be a positive contributor to the outcome.
Q. Are you expecting another push to require hedge fund managers to register as investment advisers?
A. I think registration of some sort will certainly be discussed. But as I've said, 70% of our members are registered already, so it's not as controversial a subject as some might assume. The question is, registration and then what?
If it's merely to get someone's name, address and serial number, that's one thing. But I don't know that that's going to be where the effort will end.
I would have to point out that there were any number of significantly regulated entities in the current financial meltdown, not the least of which were Fannie Mae [in Washington] and Freddie Mac [in McLean, Va.], who started it all. And those regulated entities didn't seem to be precluded from ill-advised investments and/or risk taking, notwithstanding the significant oversight.
E-mail Jeff Benjamin at [email protected].
