They are designed to be nothing more than a humorous compilation of commonsense things men are expected to do.  Edicts such as “all injuries can be treated by walking it off” or “No man shall ever tuck a team jersey into his pants” seem obvious to anyone who has ever witnessed a sporting event. Created by the Miller Brewing Company, the Man Laws from the Men of the Square Table represent a tongue-in-cheek list of do’s and don’ts designed to guide men through such difficulties as when it is acceptable to leave a game (never before the end), when it is okay to date a dumped friend’s girl (six months) and whether or not you should carry an umbrella (okay but never twirl it).

But there are another set of man laws being passed that have the same ironic nature with not so frivolous consequences. The President’s Working Group recently decided that, in good old boy financial tradition (women seem to be conspicuously absent from this moneyed conversation) that hedge funds are doing just fine.

With more than a passing relationship with hedge fund industry, distinguished alumni from Goldman Sachs such as Treasury Secretary Henry Paulson, former chairman of the investment firm, his number one deputy, Robert K. Steel and Joshua Bolton, White House Chief of Staff announced their findings recently about the nature of private equity and how it could affect the average investor.

Hedge funds were, without a doubt involved in the events of the past week.  The Yen carry trade, a sophisticated financial maneuver that involves the borrowing of one currency available at low rates (the Yen can be purchased for 0.50% - significantly off its low of zero percent), converted to dollars and then used it to buy risk in the form of high yield debt. 

This works as long as the currency stays cheap; the spread between what is owed and what is received, as yield is worth the risk and of course, the dollar remains weak.  It was the unraveling of this so-called carry trade that began the landslide effect around the world.

Hedge fund investing has created increased risk for the average investor. Requests for additional transparency have been resisted by the industry for a number of valid – at least to those that run hedge funds -reasons. Now the President’s Working Group has agreed that additional oversight is not needed. 

Hedge funds assume often-outsized risk to reap rewards for their investors. Hedge fund managers, many of whom were former mutual fund managers celebrated for their accomplishments in that well-regulated industry, often use a wide variety of investment tools to create and protect the wealth of their clients.  Transparency would, many claim, hinder that pursuit and jeopardize their efforts. Any additional regulation, of which there is very little, would, as Treasury Secretary Henry Paulson suggested stymie innovation and create an environment of calculated risk.  

Joining this group and siding somewhat characteristically with Wall Street was Christopher Cox, the Securities and Exchange Commissioner.  His predecessor, William H. Donaldson has been an outspoken opponent of this somewhat shadowy industry strongly disagreeing with the status quo. 

Mr. Donaldson has been central in this push for regulations accusing regulators of failing to clearly understand how the behind the scenes manipulation of certain markets trickles down to all investors.  Mr. Donaldson has gone so far as to call this $1 trillion industry a “dark corner”.

The result of this recommendation from this group of top economic advisors reveals a shockingly benign attitude toward the industry.  

The growth of hedge funds has changed the way Wall Street conducts business.  Catering first to these private pools of capital, the Working Group agreed with Wall Street suggesting that hedge fund investors knew the risks they are taking and embrace the sophistication of the investment.  The complexity of these funds and their use of often opaque and illiquid techniques to generate income for their investors demands more from those who put money into these funds.

Seeking to avoid the kind of requirements forced on mutual funds, the decision to allow hedge funds to operate without the watchful eye of regulators was hailed by agencies such as the Securities Industry and Financial Markets Association.  Hedge funds, they contend, operate best in a flexible and efficient marketplace.

Micah Green, co-CEO of SIFMA called the Group’s guidelines thoughtful.  SIFMA, it should be noted, represents the shared interests of more than 650 securities firms, banks and asset managers. 

One question remains unanswered. The average investor did not fuel the sudden rush for the exits last week.  Yet, it was the individual investor who bore the brunt of those losses.  How do you oversee an industry whose narrow focus for their own clients result in a scattershot result for all investors? 

Citing secrecy as an indispensable tool, hedge funds have pointed to the in-place regulations lovingly referred to as principles practiced by the financial institutions they do business with as sufficient protection for all investors.  What the Working Group has rejected is healthy skepticism.

Hedge funds have their advocates on both sides of the pond.  Former accountant and head of the European Union Charlie McGreevy recently weighed in on the subject agreeing with the Working Groups recommendation to leave well enough alone. He believes that principles can guide the industry better than rules.  Al Capone once quipped that, “it's strange that men should take up crime when there are so many legal ways to be dishonest.”  

The financial markets have an obligation to all of its participants.  Risk is necessary.  Unfortunately, not all money managers are created from the same highly principled template. Imagine sports where the only rule was based the principles of the participants.

© 2007 Paul Petillo
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