UK prime minister Gordon Brown has made clear his views on hedge funds, saying that whatever name financial institutions go by, they should be supervised according to what they do. In March, G20 finance ministers agreed that hedge funds and their managers should be registered and have to “disclose appropriate information to assess the risks they pose”. In the US, discussions are taking place at federal and state levels as to how hedge fund supervision should play out.
Phillip Goldstein, founder of Bulldog Investors and the man who successfully sued the SEC for illegally forcing hedge funds to register, is doubtful that additional regulation will help prevent fraud. “There is a misconception that more rules are required, but there are already rules in place,” he says. “Fraud is already illegal and the rules do not prevent it. Enforce the rules we have before making new rules. If you have a wave of bank robberies, you don’t need even more video cameras and locks. You need better enforcement procedures.”
Goldstein says resources at the SEC need to be redirected to focus on enforcing the rules that will be most effective. “There are many rules in place that are a waste of resources and time,” he says. “Things like having to send things in by FedEx still, or sending five copies of reports – someone needs to go review the rule books, remove the obsolete rules, and then move resources to the rules that are necessary and that may help enforce against fraud.”
The SEC has come under criticism for failing to react to red flags at the Madoff funds and Westridge Capital. In both cases the funds were registered with the SEC. John Godden, founder of hedge fund consultant IGS Group in London, agrees that increased regulation is not the answer. “It wasn’t a lack of regulation or industry good practice that allowed Madoff to flourish,” he says. “It was fraud, lies and lack of applying the laws. Increasing regulation is about more monitoring not more rules. You can’t regulate against stupidity, and criminals don’t comply anyway.”
Revamped policies
The SEC has said it will revamp its whistle-blower policies in addition to reviewing its enforcement procedure. Encouraging whistle-blowing instead of regulation will have a greater impact, believes Goldstein, who says most frauds are caught by insiders alerting the authorities. In his testimony to Congress, Harry Markopolos, a Boston fraud investigator who repeatedly alerted the SEC to Madoff, urged the creation of a whistle-blower office. “Complaints from within the industry or by investors have got to be the cheapest, most effective way to identify fraudsters, yet this valuable resource is currently ignored by the SEC,” he said. At the same time, Finra, the securities industry self-regulating agency, has said it also plans to be more responsive to whistle-blowers, setting up a new office to field tips.
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“Whistle-blowing has a place, but it is by no means a substitute for proper controls and a regulatory framework” John Donohoe, Carne Global Financial Services |
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Participants question, however, whether encouraging whistle-blowing would benefit Europe’s hedge fund industry. Legislation in France has made whistle-blowing hotlines difficult to implement in the EU. Also, “culturally, whistle-blowing is not as welcomed in Europe as it is in the US,” says a partner at a European law firm. Eastern European countries, in particular, are cautious about whistle-blowing. A survey of UK employees by Ernst & Young, however, revealed a similar comfort level with whistle-blowing as in north America. Asia is even more reticent than Europe. Ernst & Young’s global fraud survey last year revealed Japan to be the least likely region to call whistle-blowing a successful measure for minimizing corruption. John Donohoe, chief executive of hedge fund adviser Carne Global Financial Services, says it is not only a case of a cultural difference. He believes that whistle-blowing might have a part to play in reducing fraud but is far from being a panacea. If the US does not look to other solutions, European investors will not feel comforted. “Whistle-blowing has a place, but it is by no means a substitute for proper controls and a regulatory framework,” says Donohoe. Already, he points out, there is some element of whistle-blowing present, with auditors and directors expected to speak up if they discover irregularities or suspect fraud. What appears to be more pressing for the US in order to reduce fraud, he says, is to rethink the structures. “The structure of European hedge funds forces independent directors to sit on the board, and funds are independently administered,” he says. “Most European managers are regulated by the FSA [the UK’s Financial Services Authority]. The use of independent directors is limited in the US funds, especially on the GP of the Master Fund, and that is a key control. Many European investors have said they will not invest in US managers without independent boards and administrators for their funds. In Europe, the independent oversight model has worked where there are strong boards and administrators, and investors want to see the US following suit. In fact a number of our European hedge managers are moving to regulated funds to give them a competitive advantage. Investors want more robust investment structures in place and controls, rather than relying on some whistle-blowers.”
