Guidelines for safeguarding the hedge fund industry released yesterday by the Bush administration drew applause from much of Wall Street for its measured tone and criticism from some lawmakers and industry observers who complained the report’s recommendations were too weak.
The administration, in an agreement with the top United States regulatory agencies, said Thursday that there was no need for greater government oversight of the rapidly growing hedge fund industry and other private investment groups to protect the nation’s financial system.
Instead, they announced that investors, hedge fund companies and their lenders could adequately take care of themselves by adhering to a set of nonbinding principles.
The principles, many already being followed by the sharpest investors and best-run companies, say that investors should not take risks they cannot tolerate and should carefully evaluate the strategies and management skills of hedge funds. They also call for funds to make clear and meaningful disclosures to investors.
But Richard Blumenthal, attorney general in Connecticut, home to many hedge funds, said the new guidelines did not adequately protect investors. “These vague recommendations lack substance and specifics, making them unenforceable,” he said in a statement. “In a perfect world, everyone would already follow these guidelines, but in the real world we need real protections.”
“A lot more teeth and a lot more specificity is required” to oversight of the hedge fund industry, Mr. Blumenthal said. “There will be efforts on the part of states to provide guidelines if the federal government doesn’t.”
Forbes.com’s Liz Moyer suggested the guidelines amounted to a “caveat emptor” approach. “[T]he President’s Working Group on Financial Markets released only a vague set of guidelines and ‘principles’ and left it largely up to banks, funds and the markets to sort out the details,” she wrote. “Not surprisingly, Wall Street was delighted by the failure of the working group to act.”
The recommendations came after months of study by a presidential working group of top officials and regulators. They looked at both the hedge fund industry, which has more than $1 trillion in assets, and the management of private equity firms, which take direct control and ownership of companies rather than relying on large numbers of outside stockholders.
The New York Times said that the group’s conclusions reflected both the strong antiregulatory ideology of the administration and the formidable influence of Wall Street and the increasingly wealthy hedge fund industry among both Democrats and Republicans in Washington.
It noted that three of the administration’s most senior economic policy makers — Treasury Secretary Henry M. Paulson Jr., his top deputy, Robert K. Steel, and White House chief of staff Joshua Bolten — are alumni of Goldman Sachs, which in the last decade has evolved into one of the most important players in the private equity market.
And, the Times wrote, the decision to avoid demanding more openness from private funds represents a starkly different approach to that undertaken by Washington for publicly traded companies, which in the last five years have faced a battery of new governance, auditing and disclosure rules following the scandals at Enron and other large companies.
Writing in his Financial Armageddon blog, markets commentator Michael Panzner said that the decision “suggests that Pollyanna is back — with a vengeance — in regulatory circles.”
The working group rejected any proposal that would give the government the ability to inspect the books and records of hedge funds or force the funds to make regular reports about their activities. Both banks and brokerage firms must adhere to stringent rules that give regulators great leeway in supervising them.
While the working group never considered anything as strict, many hedge funds oppose even minimal oversight because they say it could slow their ability to make lightning-fast investment decisions or reveal trading strategies to rivals.
The report said that the concerns of less sophisticated investors in pension and retirement vehicles could best be addressed “through sound practices on the part of the fiduciaries that manage such vehicles.”
The announcement was hailed by several trade groups for the hedge funds and other companies involved in trading complex financial instruments.
“The President’s Working Group has taken a thoughtful and judicious approach to many of the investor protection and systemic risk issues which surround hedge funds,” said Micah S. Green, co-chief executive of the Securities Industry and Financial Markets Association, which represents hundreds of Wall Street firms.
“Too often, regulators reach immediately for new laws or rules which can have the unintended consequence of stifling innovation or smothering markets,” Mr. Green said. “By instead providing principles and guidelines, the President’s Working Group has recognized the importance of flexibility and efficiency in a healthy marketplace.”
The reaction in Congress, which is in recess this week, was largely muted.
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