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PERSPECTIVES ON HEDGE FUND REGISTRATION 

HEARING 

BEFORE THE

SUBCOMMITTEE ON CAPITAL MARKETS, 

INSURANCE, AND GOVERNMENT 

SPONSORED ENTERPRISES 

OF THE

COMMITTEE ON FINANCIAL SERVICES 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED ELEVENTH CONGRESS 

FIRST SESSION 

MAY 7, 2009 

Printed for the use of the Committee on Financial Services 

Serial No. 111–29 

( 

(II) 

HOUSE COMMITTEE ON FINANCIAL SERVICES 

BARNEY FRANK, Massachusetts, Chairman 

PAUL E. KANJORSKI, Pennsylvania 

MAXINE WATERS, California 

CAROLYN B. MALONEY, New York 

LUIS V. GUTIERREZ, Illinois 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

GARY L. ACKERMAN, New York 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

DENNIS MOORE, Kansas 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

MELISSA L. BEAN, Illinois 

GWEN MOORE, Wisconsin 

PAUL W. HODES, New Hampshire 

KEITH ELLISON, Minnesota 

RON KLEIN, Florida 

CHARLES A. WILSON, Ohio 

ED PERLMUTTER, Colorado 

JOE DONNELLY, Indiana 

BILL FOSTER, Illinois 

ANDRE ́ CARSON, Indiana 

JACKIE SPEIER, California 

TRAVIS CHILDERS, Mississippi 

WALT MINNICK, Idaho 

JOHN ADLER, New Jersey 

MARY JO KILROY, Ohio 

STEVE DRIEHAUS, Ohio 

SUZANNE KOSMAS, Florida 

ALAN GRAYSON, Florida 

JIM HIMES, Connecticut 

GARY PETERS, Michigan 

DAN MAFFEI, New York 

SPENCER BACHUS, Alabama 

MICHAEL N. CASTLE, Delaware 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

RON PAUL, Texas 

DONALD A. MANZULLO, Illinois 

WALTER B. JONES, JR., North Carolina 

JUDY BIGGERT, Illinois 

GARY G. MILLER, California 

SHELLEY MOORE CAPITO, West Virginia 

JEB HENSARLING, Texas 

SCOTT GARRETT, New Jersey 

J. GRESHAM BARRETT, South Carolina 

JIM GERLACH, Pennsylvania 

RANDY NEUGEBAUER, Texas 

TOM PRICE, Georgia 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

ADAM PUTNAM, Florida 

MICHELE BACHMANN, Minnesota 

KENNY MARCHANT, Texas 

THADDEUS G. McCOTTER, Michigan 

KEVIN McCARTHY, California 

BILL POSEY, Florida 

LYNN JENKINS, Kansas 

CHRISTOPHER LEE, New York 

ERIK PAULSEN, Minnesota 

LEONARD LANCE, New Jersey 

JEANNE M. ROSLANOWICK, Staff Director and Chief Counsel 

(III) 

SUBCOMMITTEE ON CAPITAL MARKETS, INSURANCE, AND GOVERNMENT SPONSORED

ENTERPRISES

PAUL E. KANJORSKI, Pennsylvania, Chairman 

GARY L. ACKERMAN, New York 

BRAD SHERMAN, California 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

NYDIA M. VELA ́ ZQUEZ, New York 

CAROLYN B. MALONEY, New York 

MELISSA L. BEAN, Illinois 

GWEN MOORE, Wisconsin 

PAUL W. HODES, New Hampshire 

RON KLEIN, Florida 

ED PERLMUTTER, Colorado 

JOE DONNELLY, Indiana 

ANDRE ́ CARSON, Indiana 

JACKIE SPEIER, California 

TRAVIS CHILDERS, Mississippi 

CHARLES A. WILSON, Ohio 

BILL FOSTER, Illinois 

WALT MINNICK, Idaho 

JOHN ADLER, New Jersey 

MARY JO KILROY, Ohio 

SUZANNE KOSMAS, Florida 

ALAN GRAYSON, Florida 

JIM HIMES, Connecticut 

GARY PETERS, Michigan 

SCOTT GARRETT, New Jersey 

TOM PRICE, Georgia 

MICHAEL N. CASTLE, Delaware 

PETER T. KING, New York 

FRANK D. LUCAS, Oklahoma 

DONALD A. MANZULLO, Illinois 

EDWARD R. ROYCE, California 

JUDY BIGGERT, Illinois 

SHELLEY MOORE CAPITO, West Virginia 

JEB HENSARLING, Texas 

ADAM PUTNAM, Florida 

J. GRESHAM BARRETT, South Carolina 

JIM GERLACH, Pennsylvania 

JOHN CAMPBELL, California 

MICHELE BACHMANN, Minnesota 

THADDEUS G. McCOTTER, Michigan 

RANDY NEUGEBAUER, Texas 

KEVIN McCARTHY, California 

BILL POSEY, Florida 

LYNN JENKINS, Kansas 

(V) 

C O N T E N T S 

Page 

Hearing held on: 

May 7, 2009 ....................................................................................................... 1 

Appendix: 

May 7, 2009 ....................................................................................................... 53 

WITNESSES 

THURSDAY, MAY 7, 2009 

Baker, Hon. Richard H., President and CEO, Managed Funds Association ...... 10 

Chanos, James S., Chairman, Coalition of Private Investment Companies ....... 14 

Groome, W. Todd, Chairman, The Alternative Investment Management Association (AIMA) ...................................................................................................... 12 

Harris, Britt, Chief Investment Officer, Teacher Retirement System of Texas . 16 

Williams, Orice M., Director, Financial Markets and Community Investment, 

U.S. Government Accountability Office .............................................................. 9 

APPENDIX 

Prepared statements: 

Kanjorski, Hon. Paul E. ................................................................................... 54 

Baker, Hon. Richard H. ................................................................................... 56 

Chanos, James S. .............................................................................................. 77 

Groome, W. Todd .............................................................................................. 102 

Harris, Britt ...................................................................................................... 127 

Williams, Orice M. ............................................................................................ 136 

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Garrett, Hon. Scott: 

Investment Business Daily editorial entitled, ‘‘Don’t Demonize Chrysler’s 

Debt Holders for Standing up for Their Shareholders,’’ dated May 4, 

2009 ................................................................................................................ 154 

Speier, Hon. Jackie: 

Article from the Washington Post entitled, ‘‘Hedge Funds Get Tangled 

in Bad-Business Cycle,’’ dated October 19, 2005 ........................................ 156 

Baker, Hon. Richard H.: 

Responses to questions submitted by Hon. Bill Foster ................................. 158 

Responses to questions submitted by Hon. Jim Himes ................................. 161 

(1) 

PERSPECTIVES ON HEDGE 

FUND REGISTRATION 

Thursday, May 7, 2009 

U.S. HOUSE OF REPRESENTATIVES, SUBCOMMITTEE ON CAPITAL MARKETS, INSURANCE, AND GOVERNMENT

SPONSORED ENTERPRISES, COMMITTEE ON FINANCIAL SERVICES, Washington, D.C. 

The subcommittee met, pursuant to notice, at 11:09 a.m., in room 

2128, Rayburn House Office Building, Hon. Paul Kanjorski [chairman of the subcommittee] presiding. 

Members present: Representatives Kanjorski, Ackerman, Sherman, Capuano, Lynch, Scott, Bean, Hodes, Klein, Donnelly, Carson, 

Speier, Foster, Grayson, Himes, Peters; Garrett, Castle, Lucas, 

Royce, Biggert, Capito, Campbell, Posey, and Jenkins. 

Ex officio present: Representative Bachus. 

Chairman KANJORSKI. This hearing of the Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises 

will come to order. 

Pursuant to committee rules, each side will have 15 minutes for 

opening statements. Without objection, all members’ opening statements will be made a part of the record. 

During the past 2 years, our markets have experienced tremendous turmoil as an economic tidal wave crushed down and resulted 

in the loss of trillions of dollars for investors, the drowning of several companies, and the disappearance of some products and industries. Because we need to decrease the likelihood of similar situations occurring again in the future, regulatory reform has become 

a topic for considerable debate in Washington. 

Today, we will examine one sector of our markets in need of 

greater oversight, hedge funds. Our singular focus on hedge funds 

at this hearing, however, should not be taken to mean that we will 

not revisit the need for oversight of other pools of unregulated capital, including private equity and venture capital. We must also 

recognize that hedge funds are not villains, as some might seek to 

infer, although there are almost certainly a very small number of 

bad ones. 

As has happened many times before, this latest financial crisis 

has revealed that our system of capitalism cannot thrive without 

a responsible and thoughtful degree of transparency. The question 

before us today is how Congress can wisely improve hedge fund 

oversight. We must not regulate for the sake of regulation. Moreover, we should refrain from adding layers of an antiquated patchVerDate Nov 24 2008 17:52 Sep 24, 2009 Jkt 051588 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 K:\DOCS\51588.TXT TERRIE
2 

work structure that has become in some instances counterproductive. 

In my current view, hedge funds deserve a narrowly tailored regulatory treatment. If they want to continue to swim in our capital 

markets, they must at a minimum fill out the forms and get an annual pool pass. In this regard, Congressmen Capuano and Castle 

have drafted a good bill to accomplish the goal of registering hedge 

funds and investment advisors. 

Registration generally makes sense, although we may need to 

customize the rules to treat small firms differently from big ones. 

We can best achieve this objective by providing the Securities and 

Exchange Commission with some flexibility in the implementation 

of the hedge fund registration law. As we work to put in place a 

system to obtain greater transparency for the hedge fund industry, 

we must also make other important decisions about who will monitor them and how. 

Because of their sophistication, we should allow hedge funds to 

continue swimming in the deep end of the pool. However, we also 

do not want to see them drown, especially in some future financial 

crisis. As such we need to determine whether they need a lifeguard 

on watch at all times or whether they can merely follow some general behavioral rules posted on a wall. 

Moreover, we must consider how to protect less experienced 

swimmers in our markets who might be overwhelmed by the wave 

created when one hedge fund jumps into the pool with a cannonball 

dive. Hedge fund activities directly affect the fortunes of pension 

funds and institutional investors. Indirectly, teachers and other 

hardworking Americans are heavily invested in hedge funds, but 

many of them were unaware of the risks involved until this crisis. 

When the market soars and hefty returns are made, no one really cares. Business cycles happen, and fortunes can fade fast. We 

need a system that better protects individuals’ retirement funds. 

We must ensure that nest eggs do not disappear as a result of excessive risk taken by pension managers. We have painfully witnessed enough of that last year. 

In sum, investors need to regain trust and confidence in our markets and legislation aimed at shining a light on a previously unregulated $1.5 trillion corner of the market will help to accomplish 

that end. Striking a balance of all of these complicated questions 

is the task before us. 

I look forward to working in a bipartisan manner with other 

members to design an effective, transparent regulatory system to 

govern hedge funds going forward. 

And now I would like to recognize my ranking member, Mr. Garrett, for 4 minutes for his opening statement. 

Mr. GARRETT. Thank you. I thank the chairman and I thank all 

the witnesses who are about to testify, and I certainly look forward 

to delving into the issues raised in the registration legislation by 

Congressmen Castle and Capuano. 

But before I do, I want to take a moment to address President 

Obama’s recent comments about the hedge fund industry as it relates to the Chrysler bankruptcy. I was troubled by the President’s 

recent statements that singled out a particular class of Chrysler’s 

creditors. The President’s comments displayed a complete disregard 

3 

for the rule of law as well as practices which govern our bankruptcy code. 

Furthermore, the comments, to me, showed a fundamental misunderstanding of just who hedge fund managers represent as well 

as the fiduciary responsibilities these managers have to their investors. Millions of retired teachers and other public employees have 

their retirement savings invested in these funds, and it was due to 

investors like these that Chrysler was able to stay out of bankruptcy as long as it did. And it wasn’t just the President’s public 

comments that were concerning. There were also reports that members of this Administration bullied and threatened investors to accept the Administration’s terms or else. 

As we examine the potentially increasingly regulation on hedge 

funds purportedly to protect investors in the broader economy, perhaps we should also be looking at ways to protect hedge funds, the 

retirees, and the teachers who invest in them in other parts of the 

economy as well from the over-zealous, strong-arming, and inappropriate meddling on the part of some in the Federal Government. 

But let’s get back to the topic of our hearing today, hedge fund 

registration. We will no doubt hear from members of this committee and maybe the panel that registration is a good thing. I 

hope that others here today, however, will indulge me as I raise 

some concerns that I have with this approach. First, let’s step back 

for a moment and remember that hedge funds were not the cause 

of our financial sector difficulties. In fact, they are now being called 

upon by the government to help pull the banking sector—which as 

we know is one of the most heavily regulated sectors—out of our 

current hole. 

Secondly, the due diligence performed by sophisticated institutions that invest in hedge funds is significantly more rigorous than 

anything that they will be subject to under a registration regime. 

So I am weary that the perceived government imprimatur provided 

by mandatory registration may now undermine or de-emphasize 

that due diligence over time. 

And perhaps more importantly, without mandatory registration, 

there is no current expectation by the financial markets that taxpayers would ever be required to bail out a hedge fund, but once 

you introduce government oversight, expectations change. An additional concern with this approach is that it approaches reform in 

a piecemeal fashion rather than as part of a comprehensive plan 

to address reform of the entire financial sector. All the pieces of reform should fit together and should be pursued as part of one complete package. 

And finally, while registration may not seem overly onerous to an 

industry where many of the participants already voluntarily register, I am concerned that mandatory registration is a proverbial 

camel’s nose under the tent. In fact, earlier this week, SEC Chairman Schapiro announced her intention to go further. She said it is 

probably not enough to register hedge funds. It may well be necessary to put in place particular kinds of rules. She went on to say 

it is certainly possible that the SEC should consider forcing hedge 

funds to publicly disclose short sale positions and pose restrictions 

on leverage and restrict what hedge funds could invest in. Is that 

what we are leading to? 

4 

So finally, again, big banks are among the most heavily regulated firms in our economy, yet are the root cause of many of our 

problems. But at least with banks there is a rationale that regulation is there to protect the individuals and insure deposits. With 

hedge funds, investment managers are sophisticated and there are 

no insured deposits to protect. So let’s be very careful about regulations and registrations that could ultimately lead to fundamentally 

changing the nature of a very important investment option that is 

available now for millions of Americans. 

And with that I yield back, and I just ask unanimous consent to 

enter into the record an Investment Business Daily editorial from 

earlier this week entitled, ‘‘Don’t Demonize Chrysler’s Debt Holders 

for Standing up for Their Shareholders.’’ 

Chairman KANJORSKI. Thank you, Mr. Garrett. And now we will 

have Mr. Capuano for 3 minutes. 

Mr. CAPUANO. Thank you, Mr. Chairman, and thank you very 

much for organizing this hearing. 

Ladies and gentlemen, I’m looking forward to your testimony, 

and I think that most thoughtful people have now come to the conclusion that transparency in our large economic plans and our 

large financial plans is essential to an effective market. 

Let me be very clear. My interest is not in targeting hedge funds 

at all. My interest in hedge funds started because a few years ago, 

5 or 6 years ago, hedge funds were the major players in the entire 

financial world that were not subject to regulation or oversight or 

even registration. It has become clear now that you are just one of 

many private equity funds, sovereign wealth funds. There might be 

others. 

And I will be clear. I am not interested really, terribly too much 

in any one or even a small number of hedge funds. I’m not interested all that much in a few wealthy players gambling their own 

money at their own risk as they see fit. Those things don’t bother 

me. What bothers me is the herding mentality that happens, what 

bothers me is the growth—and again, of hedge of funds, only because you are here today, you are not the only ones. 

When I started looking at this, nobody knew, but people thought 

there might be fewer than 1,000 hedge funds. Today, nobody 

knows, but they think there might be upwards of 8,000 to 10,000 

hedge funds. Now if there are 8,000 brilliant, sophisticated investors out there who can beat the system every time, you are going 

to have to prove that to the world because no one really believes 

that. 

We are here today to talk about how to move forward, and moving forward to me is not over-regulation. I know that any time anybody in government suggests a little transparency, those who want 

to keep the opaqueness of anything argue, ‘‘Oh, government regulation will ruin everything.’’ The SEC did a pretty good job for a long 

time with reasonable regulation. That is the concept here, simply 

allowing investors to know what they are investing in. I don’t think 

it is that difficult, simply allowing—especially if we end up with a 

systemic regulator, which I think and hope we will—that they understand how the system works. 

We cannot have major players in the financial world completely 

operating in the dark, answerable to no one. It is not just for the 

5 

individual investors. Again, if some billionaire wants to risk $100 

million and lose it, that doesn’t jeopardize my life, it doesn’t jeopardize my mother’s pension, but it does when those players expand 

exponentially and start getting money out of pension funds. When 

they start getting money out of other public funds, that is when I 

believe we have a societal interest in what is going on, and that 

is really what this is all about today. 

And the bill that Mr. Castle and I filed, in my opinion, is simply 

a beginning. It is a bill based on some old concepts, in my mind, 

that have actually changed and gotten a little tighter with understanding the new problems that we have. 

But I want to be very clear. Today it is hedge funds. I do not see 

hedge funds as evil, I do not see them as the major cause of any 

problem. They participated in it like anyone else. I also want to be 

very clear in my opinion that regulated banks did not cause this 

problem. They played with it, no question about it, but the problems we have today were caused by a lack of transparency in credit 

default swaps and collateralized debt obligations and other such 

items where everyone was playing. And all I want in the final analysis is a little transparency so that the market can honestly judge 

what is being done for it and to it. 

With that, Mr. Chairman, I yield back, and I thank you very 

much. 

Chairman KANJORSKI. Thank you very much. Now we will hear 

from Mr. Castle for 3 minutes. 

Mr. CASTLE. Thank you very much, Mr. Chairman. I thank you 

and the ranking member for holding this hearing today. We appreciate it. 

Mr. Chairman, over the last decade the number of hedge funds 

has grown, as we have already heard earlier. The assets they have 

in their management obviously has grown, and their ability to 

shake up the marketplace has undoubtedly grown too. 

And as I looked over news stories and industry literature and 

discussed these issues with fund managers and investors back 

home, it struck me the time was probably right to examine hedge 

funds more carefully and understand more precisely their role in 

the marketplace. 

The popularity of hedge funds among sophisticated investors 

speaks for itself and I have no particular agenda here. But I do 

think the time has come, and I think most in the industry would 

agree that knowing some very basic information about the funds 

and their managers is not too much to ask. Furthermore, providing 

the Securities and Exchange Commission with this information and 

the ability to examine the funds from time to time seems prudent 

to me. 

Finally, Mr. Chairman, I want to thank my colleague from Massachusetts, Mr. Capuano, for joining me in the introduction of several hedge fund bill proposals. 

I also listened to the opening statement of our distinguished 

ranking member, Mr. Garrett, and I happen to be in agreement 

with him on certain aspects of that. While I think there should be 

transparency, we are looking for a way of reaching that—clearly, 

as he has indicated, sometimes when you get government oversight, expectations change, and I hope bailing out hedge funds 

6 

would not be one of those potential expectations that might be 

reached. In fact, I think it should be legislated out specifically if 

we were to do anything. But we do have to be careful about that. 

I mean he is essentially correct. When we get the government involved in anything, even simple oversight and transparency, we 

need to be careful not to be overreaching with respect to what we 

are doing. 

So I understand we need to be in balance. I would hope we could 

strike that balance. I have read the testimony of most of the witnesses here today, and I believe that there may be a middle ground 

which we can find and which can accommodate the interests of the 

investing market and the interests of the public, and hopefully we 

can do that. 

With that, I yield back the balance of my time. 

Chairman KANJORSKI. Thank you very much, Mr. Castle. We will 

now hear from Mr. Scott for 3 minutes. 

Mr. SCOTT. Thank you very much, Mr. Chairman. 

Hedge funds now constitute $1.3 trillion in terms of their value 

as an industry, and I think as we move forward we have to understand that we have a free enterprise system. That has been the 

grounding that has made our Nation as great as it is. So as we 

move forward, we want to be mindful of how we can keep an emphasis on the word ‘‘free.’’ But I do believe we certainly need to, 

with respect to the hedge funds industry, have the ability to inspect and examine the books and records of hedge funds as well as 

acquire some increased rulemaking authority. 

Now we do not need to spend our time here today simply having 

a comprehensive session berating the hedge funds industry. We 

need to take this time today to bounce ideas and solutions back 

and forth and to remember that we must all work together on 

these important issues and respect the significance of this $1.3 trillion industry and the impact that it has on our economy and the 

taxpayers and the people of our country. 

I do agree that legislation is necessary to compel hedge fund 

managers to provide information. But to be fair, many hedge fund 

operators have already voluntarily registered, and many hedge 

fund operators are not bad actors. There are some bad actors, but 

they are not all bad actors. 

It is of utmost importance that we continue to assess systemic 

risk related to these funds, as well as how their processes might 

be improved to ensure our financial markets are more secure in the 

future. Hedge funds indeed hold unmatched sway over our markets, and I believe supervisors must have the necessary tools to effectively monitor the systemic risk posed by hedge funds, improve 

market surveillance, assure effective oversight, and improve transparency of the level of risk in the financial markets related to 

hedge funds. 

There are a couple of key questions, one of which is very important especially with the global impact of this industry, for they are 

a global industry. Their business activity is linked to foreign entities, so the question has to be to what extent should our interaction 

be with foreign regulators as well. 

There are some very profound questions, Mr. Chairman. I appreciate this opportunity, and I look forward to the hearing. 

7 

Chairman KANJORSKI. Thank you very much, Mr. Scott. And now 

we will hear from Mr. Royce of California for 3 minutes. 

Mr. ROYCE. Thank you, Chairman Kanjorski, for holding this 

hearing today. 

While hedge funds have experienced losses, they have not asked 

for or received any direct government bailouts in an era where the 

government has become the savior of all things failed. And in the 

view of the Fed, the losses that have been borne by hedge funds 

and their investors did not pose a threat to our capital markets or 

the financial system. 

A major reason why this was the case was because of the general 

lack of leverage within the hedge fund sector. Recently we saw 

commentary by the chairman of London’s Financial Services Authority. He said that he found that the average leverage of hedge 

funds was two or three to one. Now that is a staggeringly low number, a staggeringly low amount of leverage if you consider that our 

most heavily regulated institutions like the Government Sponsored 

Enterprises Fannie Mae and Freddie Mac, were leveraged here in 

the United States by 100 to 1. 

And this was with Congress telling them how to invest and 

Members of Congress encouraging them to roll the dice on risk, encouraging them to leverage 100 to 1. I remember this quite vividly 

because we have Richard Baker, a former Member of Congress, 

here, who tried to support the position to the Federal Reserve to 

allow the Fed or the regulators to de-leverage these institutions for 

systemic risk, but that was blocked by the Members of Congress. 

So we contrast that situation with that kind of over-leverage, and 

thus far it appears counterparty risk management, which places 

the responsibility for monitoring risk on the private market participants who have the incentives and capacity to monitor the risks 

taken by hedge funds, we see that has held up pretty well. 

As we move forward with the revamping of the regulatory framework overseeing our financial system, I think it is worth noting 

that the role of hedge funds and other private pools of capital 

played in our financial system is a pretty extensive one. They 

helped the pension funds, they helped the endowments and charities and other institutional investors, and they helped them in diversifying their risk. They are an important source of capital formation and liquidity to the broader financial system. 

New regulations should take into account the benefits hedge 

funds have provided and avoid restricting the ability of institutional investors to take advantage of all alternative investments. 

I yield back the balance of my time, Mr. Chairman. 

Chairman KANJORSKI. Thank you very much, Mr. Royce. And 

now we have a vote. We are going to hear from Mr. Klein for 2 

minutes now, and then we are going to recess, take the vote, come 

back, and see who else we have who requests time. Mr. Klein? 

Mr. KLEIN. Thank you, Mr. Chairman, for holding this important 

hearing. 

Given the current turmoil in financial markets and the broader 

economy, it is important to examine hedge funds and the proper 

way to regulate these entities. Hedge funds can be stabilizing market forces, or they can pose systemic risk to the financial system. 

We have seen the liquidity problems that can arise when hedge 

8 

funds with similar market positions, particularly those with large 

amounts of leverage, are forced to sell assets in the market at the 

same time. Long-Term Capital Management is the most famous example of how the failure of one highly leveraged hedge fund can 

threaten ruin to its counterparts and break down the normal 

functionings of markets. 

Given the global nature of financial markets and the speed at 

which transactions can be made, government has a compelling interest to regulate hedge funds. Yet not all hedge funds are the 

same, and these hedge funds cover a wide range of leverage and 

investment strategies. As the GAO acknowledges, hedge funds generally add liquidity to many markets and hedge funds can play an 

important role in price discovery. They also allow other market 

participants to prudently hedge risk. We must be careful to create 

a regulatory system that allows hedge funds to remain dynamic 

market participants, but ensure at the same time that their positions don’t threaten the stability of the financial system. 

Given the diversity of hedge funds and the difficulty of 

classifying all hedge funds under one definition, it may be more 

useful to impose regulations on leverage, short sales, and offshore 

entities across all private pools of capital and do it in the proper 

way. I think the registration of hedge funds with the SEC or other 

proper regulatory authority is a good first step, and there seems to 

be a growing consensus on the necessity of registration. 

I look forward to a fruitful discussion today on the best way to 

fit hedge funds into developing systemic risk regulatory framework. 

Thank you, Mr. Chairman. 

Chairman KANJORSKI. Thank you very much, Mr. Klein. 

We are going to take a recess now for 15 minutes and then return for the remainder of the opening remarks and then go to the 

panel. The committee stands in recess. 

[recess] 

Chairman KANJORSKI. The subcommittee will reconvene, and for 

an opening statement, we will now recognize the gentleman from 

California, Mr. Sherman. 

Mr. SHERMAN. I thank the chairman. 

Three basic points. One, in drafting this bill, we should not be 

so over-inclusive as to include family partnerships or family trusts. 

I’m not sure the bill would do that, but I want to be sure before 

we proceed. Second, in general, we want to preserve the cowboy 

capitalism that has started so many new companies in this country 

and not impose excessive regulation on those entities that are 

small enough not to affect the system systemically and whose investors are sophisticated enough not to need the full measure of 

regulation. 

Finally, even if hedge funds register under the Act, that is not 

the end of the discussion of the role that hedge funds play in the 

system and system risk, and I look forward to other hearings on 

that issue to see how we can avoid a repeat of 2008. 

I yield back. 

Chairman KANJORSKI. Thank you very much, Mr. Sherman. 

We have now had all of our opening statements and we will 

move into the panel. First of all, thank you very much for being 

a part of this and appearing before the subcommittee today. WithVerDate Nov 24 2008 17:52 Sep 24, 2009 Jkt 051588 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 K:\DOCS\51588.TXT TERRIE
9 

out objection, your written statements will be made a part of the 

record. You will each be recognized for a 5-minute summary of your 

testimony. 

First, we have Ms. Orice Williams, Director, Financial Markets 

and Community Investment, U.S. Government Accountability Office. 

Ms. Williams. 

STATEMENT OF ORICE M. WILLIAMS, DIRECTOR, FINANCIAL 

MARKETS AND COMMUNITY INVESTMENT, U.S. GOVERNMENT ACCOUNTABILITY OFFICE 

Ms. WILLIAMS. Thank you. Mr. Chairman, Ranking Member Garrett, and members of the subcommittee, I am pleased to be here to 

participate in today’s hearing on hedge funds. 

As you know, a hedge fund is a pooled investment vehicle that 

is privately managed and often engages in active trading of various 

types of securities, commodity futures, and options, among others. 

In general, hedge funds qualify for exemption from certain securities laws and regulations, including the requirement to register as 

an investment company. 

When we issued our reports on hedge funds, the hedge fund sector was growing in importance and continuing to evolve within the 

financial system. Hedge funds, largely driven by investments from 

institutional investors such as endowments, foundations, insurance 

companies, and pension plans seeking to diversity their risk and 

increase returns, have grown dramatically over the last decade. 

From 1998 to early 2007, the estimated number of funds grew from 

more than 3,000 to more than 9,000 and assets under management 

grew from an estimated $200 billion to more than $2 trillion globally. About $1.5 trillion of these assets were managed by U.S. 

hedge fund advisors, but the exact number of hedge funds and assets under management is largely unknown. 

Hedge funds have significant business relationships with the 

largest regulated banking organizations. The funds act as trading 

counterparties for a wide range of over-the-counter derivatives and 

other financing transactions. They also act as clients through their 

purchase of clearing and other services and as borrowers through 

their use of margin loans from prime brokers. 

However, much has happened in financial markets since we 

issued our reports last year. According to an industry survey, most 

hedge fund strategies produced double digit losses in 2008 and 

hedge funds saw approximately $70 billion in redemptions in the 

second half of the year. Some observers have blamed hedge funds 

for dramatic volatility in stock and commodity markets, and some 

funds of hedge funds were heavily invested in the alleged Madoff 

fraud. Nevertheless, an industry survey of institutional investors 

suggests that these investors are still committed to investing in 

hedge funds in the long term. 

The general view on regulation of hedge funds appears to be 

shifting as well, perhaps signaling recognition that hedge funds 

have become an integral part of the financial marketplace, including the Treasury Secretary calling for greater oversight of hedge 

fund advisors and possible increased disclosure to regulators. 

10 

Despite changes surrounding the hedge fund sector, the issues 

and concerns related to regulatory oversight of hedge funds and 

challenges posed by hedge fund investing that were raised in our 

hedge fund reports, and more recently our regulatory framework 

report, remain relevant today. First, the oversight of hedge fundrelated activities provided by Federal financial regulators under 

their existing authorities varies and continues to raise concerns 

about the adequacy of that oversight. 

Second, pension funds face a combination of potential benefits, 

risks, and challenges in investing in hedge funds that some plans, 

particularly smaller ones, may not be equipped to manage. Third, 

while investors, creditors, and counterparties have taken a number 

of measures to impose market discipline on hedge funds over the 

past decade, market discipline has its limits, especially in good 

times. And finally, while hedge funds have not surfaced as major 

players to date in the current crisis, the potential for systemic risk 

from hedge fund-related activities remains given their interrelationships with other market participants. 

In closing, I would like to note the importance of this discussion 

as Congress considers how best to modernize the regulatory system. Ensuring that any revised regulatory system is comprehensive 

and includes a system-wide focus is vital to helping ensure that 

regulators are able to monitor markets and identify and mitigate 

issues before the crisis occurs. And having sufficient information 

about all the relevant participants, risks, and products is critical to 

achieving that goal, regardless of their legal structure or label. 

Thank you, and I will respond to any questions the subcommittee 

may have at the appropriate time. 

[The prepared statement of Ms. Williams can be found on page 

136 of the appendix.] 

Chairman KANJORSKI. Thank you very much, Ms. Williams. 

Next, we will have Hon. Richard H. Baker, the president of the 

Managed Funds Association, and a former colleague. 

Mr. Baker, welcome. 

STATEMENT OF THE HONORABLE RICHARD H. BAKER, 

PRESIDENT AND CEO, MANAGED FUNDS ASSOCIATION 

Mr. BAKER. Good morning, Mr. Chairman, Ranking Member Garrett, and members of the subcommittee. I appreciate the opportunity to visit with you this morning. 

As president and CEO of Managed Funds, we represent a significant number of hedge funds globally and remain a primary advocate for sound business practices and industry growth for professionals in hedge funds. We do provide liquidity and price discovery 

to markets, capital to allow companies to grow, and sophisticated 

risk management to investors like pension plans. I should note, as 

the GAO testimony indicated, that our funds were not the proximate cause of the ongoing difficulties in our financial markets, but 

our firms and investors have suffered like many others as a result 

of the current downturn. 

Despite these challenges—some of our firms continue to experience difficulty—we have not sought a dollar of taxpayer money, nor 

to my knowledge have any hedge funds been a significant concern 

in the current market environment as a contributor to potential 

11 

systemic risk. That is in part the result of our relative size to the 

broader financial universe, with an estimated $1.5 trillion—and 

that number varies depending on market conditions—our industry 

is significantly smaller than the $9.4 trillion mutual fund industry 

or the $13.8 trillion U.S. banking system. 

It is also a function of our strength. Hedge fund managers are 

some of the best in assessing financial market risk and in managing their own. Our managers interests are also aligned with 

those of our investors. Their money is engaged in the same investment strategy. 

And it is also a function of how we deploy credit. Today, many 

hedge funds use little or no leverage, and this has been a repetitive 

mischaracterization of our industry in reports, ‘‘the highly leveraged hedge fund industry.’’ It is a continued source of frustration. 

A recent study, which I will be happy to provide the committee, 

found 26.9 percent of hedge funds used zero leverage, and a 2009 

report by the chairman of the Financial Services Authority in London—not something that we should be able to control—that hedge 

fund leverage was on average between two and three to one industry wide for a 5-year period, significantly below many of our other 

financial service sectors. 

As a result of these factors, losses at hedge funds have not posed 

systemic risk the way that losses at more highly leveraged institutions have. 

Hedge funds have a shared interest with policymakers in establishing a sound financial system and restoring investor confidence. 

We only do well when markets function efficiently. The MFA and 

its members recognize that mandatory SEC registration for investment advisors is among many options being considered by Congress. In our view, registering investment advisors, including advisors to all private pools of capital under the Investment Advisers 

Act, is the right approach. While not a panacea, it can play an important role toward the shared goals of promoting efficiency in the 

markets, market integrity, and providing a measure of investor 

protection. 

Mr. Chairman, we didn’t come to this decision very easily at all. 

It has been debated for a considerable amount of time. But I should 

point out that over half of our members and over 70 percent of assets under management already voluntarily register with the SEC. 

What we are recommending today, however, goes beyond what 

Treasury Secretary Geithner proposed. The Secretary suggested 

only the largest fund advisors, for the purpose of systemic risk, register. What we are supporting today will subject the vast majority 

of investment advisors above some de minimis standard, which we 

do not define, to require registration. 

And it is significant. The notification letter that goes out to members pursuant to registration—the initial opening is a 20-page letter that represents hundreds of questions. We are required to make 

publicly available disclosures to the SEC, detailed disclosures to clients, procedures and policies to prevent insider trading, maintaining extensive sets of books and records, periodic inspections and examinations, requiring chief compliance officer and a written code of 

professional conduct are among only the major principal points of 

a registration requirement. We believe it is important to consider 

12 

the role of smaller investment advisors through the consideration 

of a de minimis threshold, and such exemptions should be narrowly 

constructed. 

Mr. Chairman, I look forward to working with the committee as 

you move forward. We want to be a valued resource in this most 

difficult task. Thank you. 

[The prepared statement of Mr. Baker can be found on page 56 

of the appendix.] 

Chairman KANJORSKI. Thank you very much, Mr. Baker. We appreciate your offer and I’m sure we are going to take you up on it. 

Next, we will hear from Mr. Todd Groome, the chairman of the 

Alternative Investment Management Association. 

Mr. Groome. 

STATEMENT OF W. TODD GROOME, CHAIRMAN, THE ALTERNATIVE INVESTMENT MANAGEMENT ASSOCIATION (AIMA) 

Mr. GROOME. Thank you, Mr. Chairman. I also thank the ranking member and the other members of the subcommittee for inviting AIMA to participate today in this hearing on your consideration 

of these issues related to hedge fund registration and related matters. 

AIMA is a very diverse association representing professionals 

within the industry from all over the world, different parts of the 

world. Our members come from over 40 countries. Professionals 

within our membership are hedge fund managers, investors, and 

other professionals, lawyers, accountants, and administrators involved in the industry. So we represent geographically and professionally a very diverse group of professionals involved in the hedge 

fund industry. 

After the November G20 meeting in Washington D.C., we actively engaged our members around the globe, and policymakers 

nationally and internationally, as well as other associations like 

the MFA, the Hedge Fund Standards Board, and the President’s 

Working Group to try to come together as an industry and consider 

the issues raised by the G20 and the Financial Stability Forum on 

their behalf, as well as the national authorities looking to take forward a way for the industry to respond to the financial stability related concerns raised by the G20. 

On February 24th, having completed substantially that consultation, we issued a new policy statement emphasizing, consistent 

with some of the opening statements I have heard today, an emphasis on increasing the transparency of hedge fund activities and 

markets. 

What I would like to do now with the remainder of the time is 

to highlight three or four of the key points from that policy statement. First, we support the registration of hedge fund managers 

within the jurisdictions in which they are principally based. So, for 

example, as currently structured in the United States, a hedge 

fund manager operating in the United States would register with 

the SEC, much as they have done in the U.K. for a number of 

years, and other jurisdictions. 

We have provided, in appendix three of our written testimony, a 

wide variety of examples of how that registration and pre-authorization process may be conducted. We do not believe that any parVerDate Nov 24 2008 17:52 Sep 24, 2009 Jkt 051588 PO 00000 Frm 00018 Fmt 6633 Sfmt 6633 K:\DOCS\51588.TXT TERRIE
13 

ticular method is any better than another per se, but the key point 

that I would bring from all of these examples, and it is consistent 

with some of the other opening statements, is whatever process is 

agreed upon, it needs to create an informed and ongoing dialogue 

between the hedge fund manager and the supervisory authority 

they report to. Without that informed dialogue, the exercise just increases cost and does not improve financial stability or otherwise 

benefit society. 

Second, and consistent with seeking an informed dialogue, we 

support periodic reporting requirements by larger—and I will come 

back to what ‘‘larger’’ may mean—hedge fund managers. This information should be designed to improve supervisory understanding of 

what is happening within the hedge fund industry and the portfolios of hedge funds, but also what is happening in the broader financial markets, as well as improve financial stability analysis. 

The hedge fund managers within our membership support this initiative, and view hedge funds as a mature, and as an established 

industry, and thus time to contribute to the analysis on a national 

and international basis to financial stability considerations, and in 

this sense help build the G20’s early warning system, as they have 

called it. 

The information that we recommend to include in such reports 

would be provided strategy by strategy or asset class by asset class, 

and focus not just on leverage, but also look at the liquidity in portfolios and liquidity in markets, which can be measured in a variety 

of ways, look at volatility in markets by asset class and strategy, 

and look at concentrations within portfolios and how concentrations 

tend to build in certain pockets of the market. We think this information is sufficiently important that we would encourage you to 

have a similar reporting template for banks and other non-banking 

institutions operating in our global markets. 

Third, we have called for and have been working towards a harmonization of hedge fund standards. MFA, AIMA, Hedge Fund 

Standards Board, IOSCO, the President’s Working Group, and others have created standards over the last 5 and 10 years, and we 

think it is now time to try to harmonize these on a more global 

basis. On our Web site, you can see a hedge fund standards matrix 

where we have attempted to do that, and in the last 8 weeks, we 

have been working with all of these associations to try to provide 

some input by mid-May to the Financial Stability Forum on how 

that process may look going forward. 

Supervisors may then use these converged standards in their 

dialogue with registered managers, and even expect that the larger 

hedge funds should substantially meet those standards or explain 

why they do not meet them, and thus to essentially incorporate 

them into the registration and the supervisory dialogue that we 

contemplate. 

Finally, we think there should be a de minimis test as well, probably for registration, but certainly for some of this reporting and 

other standards that I have just talked about. In our paper we 

have suggest $500 million of assets under management as a de 

minimis test on a manager and the broader hedge fund family that 

he or she manages. There is nothing magic about that number, and 

in many cases I think it makes more sense as a registration hurdle 

14 

than it does for the other hurdles. For example, the other hurdles 

could arguably be much larger. If you set such hurdles at $1 billion 

AUM, you would have over 300 hedge funds today which would 

meet that criteria, representing 80 percent of the assets in the industry, so you get a full and clear picture of what is happening. 

However, we have to also think about creating that informed dialogue that I have suggested should be the goal, and with 311 hedge 

fund managers, 70 percent of which in this country, we have to 

also ensure that we have the supervisory capacity to compile, analyze, and execute on that information. 

Thank you very much, and I look forward to your questions. 

[The prepared statement of Mr. Groome can be found on page 

102 of the appendix.] 

Chairman KANJORSKI. Thank you very much, Mr. Groome. 

And next, we will hear from Mr. James Chanos, the chairman of 

the Coalition of Private Investment Companies. 

Mr. Chanos? 

STATEMENT OF JAMES S. CHANOS, CHAIRMAN, COALITION OF 

PRIVATE INVESTMENT COMPANIES 

Mr. CHANOS. Good afternoon, Chairman Kanjorski, Congressman 

Garrett, and members of the subcommittee. I am here today testifying as chairman of the Coalition of Private Investment Companies. Thank you for the opportunity to testify on this important 

subject. 

The damage done by the collapse of global equity credit and 

asset-backed markets has been staggering in scope. There is not a 

single market participant, from banker to dealer to end user to investor, that does not have to absorb some degree of responsibility 

for the difficulties confronting us today. But while there is plenty 

of blame to spread around, there is little doubt that the root cause 

of the financial collapse we have experienced lies with the large, 

global, diversified investment and commercial banks, insurance 

companies, and Government Sponsored Enterprises under direct 

regulatory scrutiny today. 

Hedge funds and investors have generally absorbed the painful 

losses of the past year without any government cushion or taxpayer 

assistance. And as our government looks for ways to bring more 

capital into our markets, hedge funds are now seen as part of the 

solution. 

While private investment companies were not the primary catalyst for our current situation, I believe we should not be exempt 

from the regulatory modernization and improvements that you are 

developing based on lessons learned from this crisis. I would point 

out that increasing the regulation of private investment companies 

carries both risks and benefits. For example, if institutional investors believe they can rely upon the fact of direct regulation in lieu 

of conducting their own due diligence, it will undermine those parts 

of the private sector that continue to work well. 

But while there will always be a need for investor due diligence, 

Congress can give investors better tools and also provide direct 

Federal oversight of private investment funds without trying to 

wedge them under statutes written 70 years ago for other purposes, for example, the Investment Advisors Act and the InvestVerDate Nov 24 2008 17:52 Sep 24, 2009 Jkt 051588 PO 00000 Frm 00020 Fmt 6633 Sfmt 6633 K:\DOCS\51588.TXT TERRIE
15 

ment Company Act. Attempting to shoehorn hedge fund regulation 

under either of these acts will not serve to protect investors or to 

mitigate those activities that could potentially disrupt markets. 

I am a strong supporter of the SEC, its dedicated staff, and its 

mission. If we are going to put more work on the plate of this already overburdened agency, we need to provide it with a statute 

designed for the unique characteristics and activities of private investment funds. Such a statute could of course draw upon the established regulatory practices. 

To guide the development of such an oversight regime, we offer 

the following principles for your consideration. First, any new regulations should treat all private investment funds similarly, regardless of the investment strategy, including hedge funds, private equity, and venture capital. Second, a regulatory regime for private 

funds could draw upon the work of the President’s Working Group 

asset managers and investors committees. Their reports suggest 

many specific areas for improvements crafted for the unique nature 

of private investment companies, and a number of the proposed 

standards exceed the standards for other market participants currently. Third, regulation for systemic risk and market stability 

should be scaled to the size of the entity with a greater focus 

placed upon the largest funds or family of funds. 

Now let me briefly turn to what is perhaps the most important 

role that hedge funds play in our markets, the role of investor. Because of this role, CPIC believes that maximum attention should 

be paid to maintaining and increasing the transparency and accuracy of financial reporting to shareholders, counterparties, and the 

market as a whole. Undermining accounting standards, for example, may provide an illusion of temporary relief, but will ultimately 

result in less market transparency and will undermine investor 

confidence, thereby lengthening the possibility of recovery. 

Private investment companies also play an important role in providing pricing efficiency and liquidity to our markets, and funds 

that engage in fundamental directional shortselling, for example, 

often play the role of financial detectives, uncovering overvalued securities and uncovering fraud. Government actions that discourage 

investors from being skeptical or that seek to throw sand in the 

gears of price discover ultimately harm investors’ interests. Indeed, 

some have conjectured that if Madoff Securities had been a public 

entity, shortsellers would have blown a whistle a long time ago. 

I would close by saying that honesty and fair dealing are at the 

foundation of investor confidence. A sustainable economic recovery 

will not occur until investors can again feel certain that their interests come first and foremost with the companies, asset managers, 

and others with whom they invest their money, and until they believe that the regulators are effectively safeguarding them against 

fraud. 

CPIC is committed to working with the committee and other policymakers to achieve this difficult but necessary goal. Thank you 

very much. 

[The prepared statement of Mr. Chanos can be found on page 77 

of the appendix.] 

Chairman KANJORSKI. Thank you very much, Mr. Chanos. 

16 

And finally, we will hear from Mr. Britt Harris, the chief investment officer for the Teacher Retirement System of Texas. 

Mr. Harris? 

STATEMENT OF BRITT HARRIS, CHIEF INVESTMENT OFFICER, 

TEACHER RETIREMENT SYSTEM OF TEXAS 

Mr. HARRIS. Thank you, Mr. Chairman. Good afternoon, ladies 

and gentlemen. My name is Britt Harris and I am the chief investment officer for the Teachers Retirement System of Texas. I am 

also a current member of the President’s Working Group on Financial Markets, the former chairman of CIEBA’s investment committee, and also the former CEO of Bridgewater Associates, which 

is perhaps the largest hedge fund in the world today. 

The Texas Teacher’s Fund is valued at approximately $80 billion, 

serves 1.2 million people. We have a long-term mandate, and we 

have an 8 percent annualized return target, and few liquidity requirements. The trust is widely diversified, and utilizes a variety 

of risk management systems, but for the purposes of this morning’s 

meeting, we have approximately 5 percent of the total trust invested in a wide variety of hedge funds, 45 in total, representing 

approximately $4 billion. 

When you think about the industry backdrop, I’m sure you all 

know that hedge funds are not new. In fact, we are aware that 

both John Maynard Keynes and Benjamin Graham both engaged 

in investment activities during the 1930’s that would have been 

called hedge funds under today’s nomenclature. 

With that said, however, until the early 1990’s, the hedge fund 

industry was relatively small and served primarily high net worth 

individuals. In the early part of the 1990’s, those individuals were 

joined by foundations and endowments and a smaller set of private 

pension funds. And then particularly in the early 2000’s, when 

hedge funds performed extremely well during an equity market 

correction, institutional investors began to use hedge funds in a 

much more dramatic fashion, and since that time they have grown 

significantly. 

And they are now, as others have said, over 8,000 in number and 

at their peak had more than $2 trillion of assets under management. It should also be noted that the evolution of the hedge fund 

client has also occurred. Today, approximately 50 percent of hedge 

fund clients are now institutional investors, whereas in previous 

periods that number would have been vastly smaller. 

Texas Teachers uses a diversified portfolio of hedge funds as an 

overall portion of its total strategy for three reasons. First, hedge 

funds are employed as a direct source of diversification, particularly during down markets. Last year’s major market declines produced hedge fund returns that were approximately 50 percent less 

than what our domestic stock market produced. That was not the 

absolute performance that we desired, but it was vastly better than 

the S&P 500. Second, properly structured hedge funds have posted 

returns of approximately 8 percent over time. That is the return 

targets for the vast majority of pension plans, and have done so 

with less volatility. And then finally, they help us to achieve our 

long-term return target. Hedge funds earn returns that are not toVerDate Nov 24 2008 17:52 Sep 24, 2009 Jkt 051588 PO 00000 Frm 00022 Fmt 6633 Sfmt 6633 K:\DOCS\51588.TXT TERRIE
17 

tally dependent on the overall market results and provide a different means for achieving returns. 

Looking at 2008, it was clearly a difficult year for global equity 

investors, among others. However, as many have already stated, 

the hedge fund industry was not the principal source of the systemic risk that developed within our markets. That risk came 

through our banking system, our insurance system, and our real 

estate markets. Still, it would be hard to conclude that hedge funds 

as a whole covered themselves with glory, using Barton Biggs’ 

term, and it is likely that the redemptions and deleveraging that 

occurred in hedge funds during the fourth quarter exacerbated that 

decline. 

We also know that difficult periods always have revealed rogue 

participants, and that was the case in 2008. And although the vast 

majority of participants in the industry operate ethically, a small 

fraction of unethical characters surfaced within the hedge fund 

community. 

While many were directly affected, the vast majority of those 

most affected were not the sophisticated institutional investors that 

I cited a moment ago. What is different about hedge funds? Rather 

than trying to track the movements of the market, most hedge 

funds try to seek return through positive returns regardless of 

market conditions. Their typical benchmark is generally some 

version of a cash proxy rather than something like the S&P 500. 

Hedge funds are able to create a certain amount of downside protection through the use of shortselling, thereby reducing market exposure. Then in order to bring their returns back to a targeted 

level, they introduce the practice of leverage. Thus, equity oriented 

risks are replaced by increased leverage. This generally works reasonably well when practiced by professional investors with good 

judgment, high ethical standards, sound investment policies, and 

solid risk controls. Because the investment approach relies more on 

skill than on the overall market, the compensation is often different and frankly more expensive and more performance oriented. 

These different objectives and different routes to investment performance have both strengths and weaknesses. I have already 

highlighted some of the strengths. The relative weaknesses are the 

reliance on leverage, a more fragile business model, lack of transparency in some cases. In most cases there is also the fact that 

they operate in perhaps the most competitive market in the world. 

So turning to regulation as a result of the recent events, renewed 

discussions are again underway regarding modifications to regulation and government oversight. At the same time, it must be pointed out that many believe that regulations that are already in place 

are more than adequate, and it is only ineffective enforcement that 

was lacking, due particularly to the lack of resources and in certain 

instances potential blind spots in the agencies themselves. 

So what is the proper response? The first objective should be to 

do no harm. When regulation is ineffective, it is generally because 

it is either inadequate or excessive. The two bimodal outcomes are 

too common, and one generally results from an overreaction to the 

other. Effective regulation does not overreach its reasonable bounds 

based solely on a more is always better approach. 

18 

Nor does it excessively regulate those who are not large enough 

to comply with the regulations and are designed to prevent outcomes that they could never realistically create. Thus I encourage 

everyone to proceed with caution, thoughtful deliberation, and in 

collaboration with others. Congress can best achieve its mission by 

focusing on a limited by unusually important set of key factors, and 

also on the types of investment organizations that might realistically create large, prolific, and systemic problems. 

We also now know that the oversight must be properly matched 

with the resources supplied. Excessive bureaucracy and a scope 

that is too broad will likely result in nothing but long-term disappointment and continued frustration to everyone. 

A one-size-fits-all process is not appropriate and is unlikely to 

work. While it is my belief that all investment organizations should 

be encouraged to apply for SEC registration, it is not appropriate 

to force all organizations to do so, and moreover, excessive reporting requirements would likely overwhelm smaller organizations 

and discourage competition and innovation. It also might reduce 

the access for smaller investors to small, high quality hedge funds. 

Three of the primary risk issues are undoubtedly systemic risk, 

fraud, and favoritism of large investors at the cost of smaller ones. 

Regarding systemic risk, it should be kept in mind a hedge fund 

is highly decentralized and comprised primarily of investment organizations managing relatively small amounts of money for investors who are defined by statute as sophisticated. At the same time, 

the vast majority of assets are controlled by approximately 50 

funds. These funds are generally very well managed and are very 

highly resourced, and collectively they are large enough to disrupt 

market activity and should be carefully monitored. These are the 

most likely sources of systemic risk and they also have very sophisticated standards. You will also be pleased to know, as has already 

been stated, that the vast majority of these are currently registered 

with the SEC today. 

The set of risks that should be monitored and disclosed should 

be focused on a relatively short list of key factors that have largely 

defined every catastrophic outcome on record. These risk categories 

are well know and they are well recognized. They include the following: assets under management in a notional sense; leverage and 

access to leverage; liquidity; concentration; counterparty risk; valuation trends in all that I have just mentioned; and the opportunity 

set within which they work. The formula for unusually negative 

outcomes is almost always the same, excessive leverage placing an 

unattractive or misvalued opportunity that is either concentrated 

or two illiquid. Thus, those are the factors that should be carefully 

monitored. 

So in conclusion, I would recommend you consider the following. 

First, understand that hedge funds are not the primary cause of 

systemic risk that we have just experienced, although it cannot be 

said that they did not contribute to its power. Thus my first request is that you seek to do no unwarranted harm. Second, do not 

seek a one-size-fits-all solution but rather focus on the funds that 

are large enough to individually or collectively create the systemic 

risk that most threaten the largest number of investors. 

19 

Third, keep your oversight practical and simple. Don’t try to 

focus on so many things that you distract yourselves from the very 

short list of key factors that truly matter. Fourth, don’t overreach 

the level and quality of resources that you are prepared to allocate 

to this area. And finally, before coming up with a litany of new and 

potentially complex and disruptive rules and regulations, look carefully at the ones that are already in place and determine whether 

they could have been applied more effectively. 

So with that said, I conclude my remarks. I will be happy to take 

questions. 

[The prepared statement of Mr. Harris can be found on page 127 

of the appendix.] 

Chairman KANJORSKI. Thank you very much, Mr. Harris. 

I want to thank the whole panel for their testimony. Certainly 

the subcommittee will have some questions, and I will start on 

mine initially. 

It seems to me it is almost unanimous. Everybody agrees that we 

should have registration. Everybody agrees that we should exercise 

some control and constraint on those hedge funds that may cause 

or contribute to systemic risk. How much regulation do we impose, 

and how do we determine what size or what manner of operation 

would trigger the best regulatory response of the government? 

I for one could care less about high-wealth individuals who want 

to contribute their money to a group of investors. If they want to 

take the shot of losing it, it does not really affect the rest of society. 

Our problem is only if these high-net-worth people invest hugely in 

a fund that leverages up like long-term capital and becomes so 

large and so pervasive that they then have the capacity to make 

so many loans from insured institutions that they cause a systemic 

risk to result. 

Now that poses a question. How large is too large? And when 

does a triggering mechanism for governmental involvement come 

into place? I am not going to direct it to anybody in particular, but 

maybe you could just take some shots at it as members of the 

panel. Mr. Baker probably has some ideas on that, and Mr. Harris 

certainly just addressed them. Mr. Baker, go on. Tell us how large 

is too large. 

Mr. BAKER. I don’t know that there is a ‘‘too large’’ answer. I do 

believe that the regulators should be constantly vigilant, because 

there are a number of variables beyond assets under management 

which could trigger systemic consequences. Some years ago, there 

was a small bank in Germany called Herstatt Bank that was involved in currency conversions and was exchanging deutsche marks 

into U.S. dollars for a bunch of New York banks. In between receipt of the deutsche marks and conversion of those into U.S. dollars they went bankrupt, leaving the New York banks unfulfilled. 

That is now known in the regulatory world as the ‘‘Herstatt 

risk.’’ No one would have looked at that institution and that activity and thought it could in any way have a relationship that would 

consequently affect so many people. Interconnectedness, leverage, 

assets under management, there are an array of things. Even market timing. If you look at the Lehman arrangement, no one knew 

the number of firms that were all engaged with that particular 

counterparty at that time. 

20 

So what may not be systemically relevant today may become relevant next month or next year, and so for that reason, we view the 

role of that systemic regulator, whomever that poor person will be, 

to be given broad authority to make those judgments based on current market conditions. 

Chairman KANJORSKI. AIG FP would fall in the same category 

that you are talking about. Who would ever have suspected that 

they put counterparty positions in place of $2.7 trillion without 

really having first line assets at risk but instead used the corporate 

assets of the insurance company back here in the States? 

That being the case though, how do we structure a situation that 

does not get charged with being too intrusive? Are we going to 

make every one of the 8,000 hedge funds disclose all possible circumstances and situations that potentially could be or could contribute to systemic risk? When I hear people argue for a systemic 

risk regulator, systemic risk seems like an after-the-fact inclusion. 

If it were discernible before-the-fact, it would not happen. 

Our problem is that if you really want to stop systemic risk as 

a regulation beforehand, you would have to have the legal authority to examine every transaction engaged in by every company and 

individual in the economy, which means we would have a totally 

controlled economy. That is the only time that we could literally 

say that systemic risk could be prevented. That is stupid and incapable of us to do. 

So our measure is going from that extreme, down to where we 

parcel out regulatory control, size of the organization, and the assets that we are going to look at. But I think in the future more 

than size of the organization or assets—I think Mr. Harris was 

making this point—the convoluted nature of the investments, the 

conduits, that are going to be developed, particularly after this disaster. 

I would say that there are going to be 50 entrepreneurs worldwide looking at insurance companies of middle size that could be 

acquired and used as methodologies of being highly speculative. If 

there is not a downturn in the market, they will be making fortunes. If there is a downturn in the market, we will discover they 

do not have any trunks on. But we do not want to go through that 

discovery, we do not want to have that problem. 

So how do we as a Congress, how do we as a government, not 

become too intrusive and yet not get caught up in a problem just 

looking at size as opposed to the convolutions they could be going 

through? And what would your opinion be, to all of the panel, as 

to prevent that being too intrusive? 

Mr. BAKER. Mr. Chairman, if that is directed to me, my observation is we have come to a very considered opinion that disclosure 

of the registration information is sufficient to give the tools to a 

well-funded and properly staffed regulator the information they 

need to make those assessments. And it would not require that regulator to be constantly involved in an individual firm’s business. 

And I would point out, Mr. Chairman, that in the current environment for our currently voluntarily registered firms, that examinations can take well over a year. They can take up to 2 years. 

There is something not appropriate about that model, and so we 

enter into this with great reservation, but we believe that discloVerDate Nov 24 2008 17:52 Sep 24, 2009 Jkt 051588 PO 00000 Frm 00026 Fmt 6633 Sfmt 6633 K:\DOCS\51588.TXT TERRIE
21 

sure of the information that is now required by the registration 

model are the appropriate items that we should disclose to a regulator to make those difficult judgments. And I’m also very glad I’m 

not sitting on your side of the dais. 

Mr. HARRIS. Just to—with respect, I think it is unrealistic to expect any organization to oversee 8,000 to 10,000 individual funds 

that are spread all throughout the world with the limited resources 

that they are going to have. 

So I would suggest a practical approach, which is the proverbial 

80/20 rule. What you have heard here is that 80 percent of the assets are with less than 20 percent of the participants. It is highly 

unlikely that you are going to get a serious systemic risk from a 

hedge fund which is less than $1 billion. The resources that are 

going to be applied to this are not sufficient to fish in every single 

pond in the entire country. And I think you divert your resources 

and make them less effective unless you focus on the areas where 

you are really, truly likely to get a serious issue. 

Mr. BAKER. Mr. Chairman, if I could just add one concern about 

that view, though. Once you identify a systemic category that is 

deemed too-big-to fail or systemically risky and that the Congress 

may likely take action, they will have a preferential pricing advantage in the marketplace, a la Fannie Mae and Freddie Mac. So that 

standard should be very malleable and not definitive, or otherwise 

you will create that advantage in capital markets. 

Chairman KANJORSKI. I know I am over my time now, but suppose that we run across the situation that size is causing extraordinary exposure to systemic risk. Should we empower the regulator 

with the power to dissolve that fund or break it apart just as a regulatory power? 

Mr. BAKER. I would be very cautious, Mr. Chairman, about the 

dissolution of business merely because of its size or assets under 

management. There should be very careful examination and 

thought given to the precedent steps— 

Chairman KANJORSKI. I agree with the thought, but should the 

power just— 

Mr. BAKER. Well although size is a considerable contributor to 

potential for systemic risk, I do not believe size in and of itself is 

of the concern that would warrant a regulator to take that action. 

Chairman KANJORSKI. Granted convoluted connections, an opportunity that lends itself, creation of the worm holes out there, if the 

regulator sees that and says that this is exacerbated by a factor of 

two, three, or four it could be a systemic risk, should we empower 

the regulator to step in and give an order of dissolving that size 

or those convoluted activities to prevent that? 

Mr. BAKER. There would be a number of alternative remedies 

that should be available to a regulator before you would get to that 

adverse conclusion, but at some point under the most adverse of 

circumstances, perhaps. But that would be a very remote and improbable outcome. 

Chairman KANJORSKI. I agree with you, but would anyone else 

like to answer? 

Mr. GROOME. Just one point, Mr. Chairman. In response to that 

last discussion between yourself and Mr. Baker, I actually like to 

think about this more as supervision, as opposed to regulation, and 

22 

so that is why you heard me talk in my remarks and our written 

testimony about providing better information to create a more informed conversation and understanding for supervisors. If a nonbank institution such as a hedge fund or any other were deemed 

to be presenting some sort of systemic risk. 

As I heard someone say in their opening comments, it is very unlikely that somebody is going to bail out or protect a hedge fund. 

What the supervisor will do, therefore, I imagine, particularly 

given Secretary Geithner’s initiatives on the resolution of nonbanks, is to wind down those institutions and protect the systemically important institutions, which are more likely to be their 

counterparties, such as banks or brokers. 

So I do not believe you need to think about it in the way of how 

do I wind down a hedge fund, or how do I dissolve a hedge fund. 

The supervisory authority at the end of the day, collectively—beyond hedge funds, but collectively—still will be looking at systemic 

risk on those institutions that provide some public good such that 

we have deemed them to be systemically important, such as banks. 

Chairman KANJORSKI. I am sorry I have taken the excess time. 

Mr. Garrett of New Jersey, you are recognized, and I will be lenient. 

Mr. GARRETT. To Mr. Baker’s comment, yes, I wish you were on 

this side of the dais too when our discussions become involved in 

this and also the GSEs issue. 

The chairman made his opening comment with regard to unanimity on the decision of regulation, and I think there might be 

unanimity on the issue of regulation. There may not be unanimity 

on whether it should be voluntary or mandatory. 

Listening to all of this, I have come away with two or three or 

four takeaways. The first one from everyone, starting with you, Ms. 

Williams, was that hedge funds were not the ultimate cause or underlying cause of the problems that we are in right now. I think 

your comment was they were not players to date in the current crisis, which I think is important in our entire discussion here. Is 

there anyone who disagrees that hedge funds were the fundamental problems here? 

[no response] 

Mr. GARRETT. No. So I think that is an important takeaway as 

we try to spend much of our time to deal with the global economic 

situation. Let us focus our attentions on what was the cause and 

not as much time on those areas it was not the cause. 

Ms. Williams also made the comment that there are dangers 

from relationships with other market players, however, as far as 

what the underlying cause was, and I assume what you meant by 

that is that hedge funds did deal with some of these other parties 

which were systemically important. And so isn’t the answer there 

not so much to direct your attention on looking at the hedge funds, 

but we do have—I think your testimony in other hearings was we 

do have regulators in place for the regulated marketplace, the 

banks and what have you, and if we looked a little more closely 

with them on what they are doing with the hedge funds and the 

derivative trades—was your earlier discussion on another panel— 

we could have possibly avoided some of this. Is that not your previous testimony and that comment here as well? 

23 

Ms. WILLIAMS. I think that is accurate. 

Mr. GARRETT. So focus on where the problem is and focus on giving authority to those regulators and make sure those regulators 

actually do their job in those other areas. 

Ms. WILLIAMS. That is definitely part of it. 

Mr. GARRETT. Second takeaway is whether or not regulation 

would have stopped the current situation we are in right now. And 

Mr. Harris, you point out—maybe you can help me with some statistics or something like that—we have voluntary regulation today, 

correct? 

Mr. HARRIS. Correct. 

Mr. GARRETT. A number of those larger institutions I believe you 

said are already registered. How long have a significant number of 

the larger institutions already been registered? 

Mr. HARRIS. For quite a while. I mean the large—my guess is 70 

to 80 percent of the largest hedge funds are fully registered and 

have been for many years. 

Mr. GARRETT. Many years. So if the issue is—and I know there 

is a little bit of debate whether we should register everybody or 

just register the systemically important ones, either way, we have 

already registered for a number of years the significantly important 

hedge funds, and so we see that registration apparently didn’t prevent us from getting into the situation. 

So we have to step back for a second and think, well, mandating 

registration of the insignificant hedge funds—whether that will 

have any impact other than creating some of the other dilemmas, 

the bailout dilemma that was referenced before, the potential of us 

stepping in, the wind down question that has been alluded to before, whether Congress will come back and say whether we should 

create authority to start winding down these things. 

So I think that is another question that we have to take away 

and consider, is that we have already had registration of most of 

those entities out there, and it hasn’t solved the problem. 

The other takeaway is that this is, for most of your opinion, just 

the start of the process as far as registration? Well, I say that because the opening comments from this panel and Mr. Capuano was 

that this is just the beginning. Mr. Sherman said this is not the 

end of the discussion. 

So were we to have a markup today and were we to pass this 

bill with registration, is it any of your understanding that Congress 

would not—and as the SEC said in my comments as well—be looking back to say registration is really not just the be all and end 

all here, we really need to have the overall supervision and some 

of these other constraints put in place. Does anybody think it is 

going to end at registration? Yes, Mr. Baker? 

Mr. BAKER. I just would hope so, Mr. Garrett. 

Mr. GARRETT. But what is the feedback from your— 

Mr. HARRIS. No one believes that. 

Mr. GARRETT. Excuse me? 

Mr. HARRIS. No one believes this would be the final word. 

Mr. GARRETT. Mr. Chanos, you made some sort of comment with 

regard to—and you made a couple of good ones. I can’t get them 

all in right now—but we are looking at hedge funds here, but I 

think you also made reference to venture capital, equity funds, and 

24 

the like. Spend just 10 seconds on that. We are looking at this, but 

you are saying if we do something, we should be looking at all of 

these guys? 

Mr. CHANOS. I think that it is important that we look at all the 

actors on the financial stage who are structured the same way because attempts to single out different groups because it is the concern of the moment doesn’t really help us sometimes prospectively. 

And if we are going to be looking at all private investment funds, 

I think there should be a framework in which we look at all of 

them in the same way. 

Having said that, I don’t think the 40 Act is appropriate for today’s financial reality. In fact, I have long personally felt that all 

of our securities acts need to be overhauled. Unfortunately sometimes it takes a crisis to bring that to the fore again, but we really 

keep trying to put a 21st Century financial system into an early 

20th Century regulatory framework. And I think that leaves a lot 

of things lacking on both ends, both on the regulatory side and on 

the investor side. 

Mr. GARRETT. I see my time is up, and I don’t know how much 

latitude he is giving me here, but I appreciate it. 

I think that is a very good takeaway to end with. Chairman 

Frank has said that we need a comprehensive look, and we have 

been doing this ourselves, of all the issues out there. And if we try 

to fit a square peg in a round hole, I guess is the expression, on 

just this one, we may be making a mistake. And if we try to do 

it just today, then we are going to come back tomorrow, someone 

else comes up with the idea for venture capital funds or equity 

trades and do them into another square hole, and then later on we 

come up with the idea of a systemic regulator. 

Well by the time we do that, we may have created a whole new— 

well maybe we wouldn’t have created a mechanism, maybe we will 

have used your analogy of the old law, which may not be the good 

one, and then we will be coming back to say, let’s revisit it again. 

So I think you raise a great point. 

And Mr. Groome, you also raised a great point—I can’t get into 

it—with regard to an informed dialogue. I don’t know where we actually have any informed dialogues at all outside in the real world 

between them and government. But I think all those things really 

have to come together in a comprehensive way rather than a piecemeal approach. 

But I appreciate the latitude and I appreciate the answers. 

Chairman KANJORSKI. Thank you very much, Mr. Garrett. And 

now we will hear from Mr. Capuano for 5 minutes. 

Mr. CAPUANO. Thank you, Mr. Chairman. 

Ladies and gentlemen, have any of you ever robbed a bank? 

[no response] 

Mr. CAPUANO. No? Have any of you ever murdered anyone? 

Mr. HARRIS. I have seen a bank robbed. Does that count? 

Mr. CAPUANO. Have any of you ever murdered anyone? 

[no response] 

Mr. CAPUANO. No? Did you not do it because there was a law or 

did you not do those things because you didn’t think it was the 

right thing to do? Did any of you not do it because the law says 

you can’t? 

25 

[no response] 

Mr. CAPUANO. You didn’t do it because you thought it was the 

right thing to do. So therefore, you would agree that on some 

things, a societal line that says you cannot cross this line through 

the versions of a law works, because those laws are written not for 

the good people of society or the good people of any group, but for 

the handful of people who would break that law, who would cross 

that line. Is that a fair statement or do you think that is an unfair 

statement? 

I assume from your silence you assume it is a fair statement? 

[no response] 

Mr. CAPUANO. That is what regulation is. It is not about the 80 

to 90 to 99 percent of any group of people who do the right thing 

and do it well and do it professionally and adequately. It is about 

the 1 or 2 or 3 or 5 percent of the people who don’t. That is what 

regulation is. Do any of you think that the SEC over the last 80 

years has destroyed the economy? 

[no response] 

Mr. CAPUANO. Do any of you think that the Fed has destroyed 

the economy? 

Mr. HARRIS. Well, we could debate that one. 

[laughter] 

Mr. CAPUANO. Reasonable regulation works. That is all we are 

talking about here. Is it a fair discussion to decide and debate 

where the appropriate line is? Of course it is. And those lines 

change over time because the economy changes, the situation 

changes, society changes. Absolutely, we all agree with that. But 

to say that there should be no regulation on some segment of any 

group belies the fact that humans have frailties. There is always 

somebody willing to cross the line. 

Let me ask another question. How many of you can tell me how 

many hedge funds are in the United States of America right now? 

How many are there? Not an estimate and not a range, how many? 

Mr. HARRIS. I think that is an unfair question. 

Mr. CAPUANO. How is it an unfair question? How many are 

there? 

Mr. HARRIS. No one would know exactly. 

Mr. CAPUANO. I can tell you how many corporations there are. 

Mr. HARRIS. Can you tell me how many private corporations 

there are? 

Mr. CAPUANO. I can tell you how many corporations there are 

that sell stock. Yes, I can. But can you tell me how much money 

is under management by those hedge funds? Not an estimate, and 

not a range, tell me. Can you tell me how much of that money is 

put forth by institutional investors, so-called sophisticated investors who apparently weren’t so sophisticated in the last year or so? 

Can you tell me how much money has been put forth by public institutional investors such as pension funds, such as yours? The answer is you can’t. I don’t think those are unreasonable questions. 

Mr. HARRIS. With due respect, you can. I don’t have that number 

right in front of me. 

Mr. CAPUANO. You can’t. Well then if you can, I would ask you 

to submit that later on—I understand you may not have that at the 

26 

top of your head—because if you can, you are the only person in 

America who can. 

Mr. HARRIS. Just keep in mind, for better or worse, every pension 

fund is public has to report, so that information is available. 

Mr. CAPUANO. I understand that. But pension funds are not the 

only ones who do it, number one, and number two, they don’t all 

report uniformly. And number three, they don’t report to a singular 

group. So I would love you to put together—I really would. I would 

appreciate if you could get every pension fund in America, especially the public funds—I would love to see that number because 

you will be the first one to ever put it together. And I would hope 

that you have the staff to do that, and I hope you do. 

How is it unreasonable to simply say we want a general look? I’m 

not trying to be prurient. I’m certainly not trying to find out the 

investment ideas of individuals. That is not what we are looking 

for. I don’t ask that from mutual funds. I don’t ask that from 

banks. I don’t ask that from pension funds. What we simply is 

when you get to the point when you can move the economy, it is 

reasonable for society to say show us something, tell us what it is. 

Yes, Mr. Baker? 

Mr. BAKER. Thank you, Mr. Capuano. I just want to point out 

that although I don’t dispute the public need for understanding of 

something that is significant in the market, there are a lot of venture capital, private equity, private partnerships, and small hedge 

funds which should not be economically subjected to a rigorous registration regime. 

Mr. CAPUANO. I totally agree. 

Mr. BAKER. And where that standard or that line is drawn is of 

course your decision, but we would like to be involved in that discussion. 

Mr. CAPUANO. Absolutely. We are on the exact same page. We 

may not be on the same page on what the answer is, but those are 

fair questions and reasonable questions. 

I would also argue that the 80/20 rule, it is a nice place to start, 

but again, without knowing the exact number, it seems that everybody agrees that hedge funds—just hedge funds, I agree. Private 

equity shouldn’t be treated any different—that anybody who can 

put enough money on the table to move a market should be subject 

to some transparency. But if the numbers is $1 trillion, 20 percent 

of that is $200 billion. It might be $2 trillion, and then we are talking $400 billion. Now if I were to sit here and suggest that $200 

billion be used, oh, say for housing, my expectation is that some 

of my colleagues might find that a little bit too much money. $200 

billion is a lot of money. It still is at least in my district. 

So I’m not saying that 80/20 is not a good place to start, but to 

simply say that that is the line, don’t look below that, and they are 

subject to nothing—especially if they act as a herd, which many of 

them do and you all know it, we all know it. And I don’t blame 

them. 

I don’t think these proposals, especially the one on the table, can 

be considered radical by anybody except those who are just absolutely beholden to the total idea of an absolute free market, which 

is fine, I respect that view, I just, number one, don’t agree with it, 

and number two, think it has been proven wrong time and time 

27 

and time again. Reasonable regulation is necessary for an effective, 

efficient, and equitable and stable economy. Where those lines are, 

as Mr. Baker points out and I totally agree, that is the discussion 

we need to have. That is the discussion. 

The discussion is no longer, I think, among reasonable people 

about whether there should be some transparency. For those who 

want to hold to that, good luck. You go home and explain it to the 

people you represent. 

Thank you, Mr. Chairman. 

Chairman KANJORSKI. Thank you very much, Mr. Capuano. Now 

we will hear from Mr. Castle for 5 minutes. 

Mr. CASTLE. Thank you, Mr. Chairman, and let me thank all of 

you. I felt your comments were thoughtful and give us some things 

to think about in terms of what we think we need to do here in 

our committee and in the Congress of the United States. 

One concern I have—I guess it is a concern—is you have cited— 

a couple of you, two or three of you cited that you are not as big 

as other entities, as, obviously, banks, but also mutual funds, etc. 

And this is may not be the right time to be mentioning growth in 

this world of investment, but I think you are probably in as much 

of a growth area as any of those entities, ultimately. 

As we see more institutional type investments going in to hedge 

funds with some of things that have made when the market has 

been stronger, I think that can return in 1, 2, 3, 5, or 10 years, 

something of that nature. So my sense is that it is something we 

need to pay a lot of attention to. We can’t be dismissive just because hedge funds aren’t as big as something else. 

And one concern I have is that a lot of what you do deals in fairly rapid market turnover, volatility, either in selling short or in 

rapid gains, or whatever it may be. While it may not be leveraged, 

as you have well pointed out here today, it still could be a great 

influence in terms of what is happening to our markets out there. 

And I’m not trying to be an expert on the markets; I don’t really 

know a lot about that or who the real buyers are or whatever it 

may be. 

But my impression, just from the little I know about hedge 

funds, is that you are dealing with a lot more volatility. It is sort 

of a welcome aspect of what you do, and that concerns me somewhat because volatility—I mean you could talk about the stability 

of it. I may talk about it as a matter of volatility, which may not 

necessarily be all good. I would be interested in your comments on 

that. 

Mr. CHANOS. If I could take a shot at that, since I think I am 

the only actual investor up on the panel here. In my day job, I actually run a hedge fund. 

First of all, as a couple of my colleagues on the panel have pointed out, hedge funds are less volatile than traditional investment 

funds, often by quite a bit. 

Mr. CASTLE. I don’t mean to interrupt you—I do mean to interrupt you, I guess. But with respect to that, while you may be less 

volatile per se, aren’t you interested in volatility? I mean you— 

maybe not you, but somebody may have a hedge fund that is selling short that wants to see volatility— 

Mr. CHANOS. Which isn’t what we do, actually. 

28 

Mr. CASTLE. Somebody else may want volatility on the upside. In 

other words, you are looking for volatility. 

Mr. CHANOS. But in fact we are often the cushion to the volatility 

against it. When people are selling in a hole, my fund, for example, 

would often be buying, and vice versa, providing liquidity on the 

other side of the market. The volatility would be worse without 

players like that in the marketplace. So that is an important factor. 

Number two, investors have lost far less money in volatile times 

in hedge funds than in more plain vanilla investment vehicles like 

mutual funds, which are highly regulated. Leverage is a concern, 

as a couple of people on the panel have expressed, and I agree with 

that. And it also needs to be in conjunction with the interconnectedness, to bring back a previous theme, of the financial system, for 

example, the banking system with the hedge fund industry. 

Going back to 1998 in the LTCM crisis, what made it so bad was 

not simply LTCM’s positions, which were considerable, but the fact 

that their lenders had actually also followed them into similar positions for their own account. Some have expressed concern about the 

rise of the shadow banking industry over the past 5 years. I know 

one professor, Andrew Lo at MIT, remarked that he was more concerned by the rise of the shadow hedge fund industry as banks and 

brokers became increasingly trading entities for their own accounts. 

So all of this is interconnected, and it is not just hedge funds. 

And when you say trading patterns for volatility, the largest hedge 

funds we saw were the trading desks of the banks and brokers. So 

it is all of our markets which have seen increased turnover, but 

hedge funds specifically are not simply the only vehicle for either 

enhancing or dampening volatility. 

Mr. CASTLE. Let me go on to Mr. Baker because I want to get 

another question in. 

Mr. BAKER. Just to follow up on Mr. Chanos’ observation, the 

goal of well-run hedge funds is to minimize potential volatility. For 

example, if you are going to go long or buy computer stock A, you 

may go short on computer stock B, just because you are skilled, you 

do your good analytics, and you think you are right. But just in 

case you are wrong, if the market goes sideways and you are short 

B, that pays off or mitigates your losses on being long on A. 

And so there are firms out there calling themselves hedge funds 

which really don’t deploy that kind of analytic skill or hedging that 

are in the market, but the members of our association do that with 

the exact intent of minimizing the downside risk. That is why, in 

the current marketplace, as Mr. Chanos has referenced, the hedge 

fund losses—although we have lost—in broad measure are far less 

than you will see in other regulated financial sectors because of 

that strategy. 

Mr. CASTLE. Mr. Chairman, may I ask another question briefly? 

Mr. Groome, if you could just give a brief answer, because I do 

want to ask another question quickly. 

Mr. GROOME. A lot of questions have been raised about high net 

worth individuals versus pension funds, and such. I am also in the 

industry as well. I am in a $3 billion fund to funds and a hedge 

fund business, and our fund to funds clients in particular are very 

large public and private pension funds and a few sovereign wealth 

29 

funds. When you ask them why they are considering hedge fund 

exposure, or even more broadly, alternative exposure, their overriding reason is to reduce volatility. So the diversification benefits 

reduce volatility in their overall portfolios. 

The second very quick point I would make—you ask about the 

size of the industry, hedge funds versus mutual funds versus 

banks. I think the size does matter to some respect, but size—as 

you heard me talk about the information template we would propose, we are talking about a variety of risk metrics. And when you 

think about the banking industry, as I think was previously noted, 

hedge funds may have been and may currently be somewhere between 1 and 3 times leveraged. 

Well banks, even in their ongoing deleveraging process, are still 

well over 30 times leveraged, and many of the major banking institutions of the world which we have been concerned about throughout the fall of 2008 were closer to 50 or 60 times leveraged and 

have moved down. So that leverage, by definition, will create significant volatility in those institutions, and if you had equal transparency of their balance sheets that you have with hedge fund balance sheets, it would be more clear. 

Mr. CASTLE. Thank you. I appreciate it. 

Let me ask another question, and I’m going to need very brief 

answers. My time is really up. You made some suggestions about 

the hedge funds, but I am concerned about private equity funds in 

general and venture capital, and some of the other things that you 

have alluded to as well in terms of their impact on the markets 

and things that we—we being the whole investing world as well as 

the public in general and us in Congress and the regulating agencies—may not know a lot about. 

And I just don’t know what your thoughts are about how we can 

deal with systemic risk and investor protection issues beyond anything we have talked about today. We have talked about registration, other things we could do, but there is a lot which is happening 

out there, and a heck of a lot of it is simply unreported at this 

time. Do you have any thoughts about that, even perhaps beyond 

hedge funds? 

Mr. HARRIS. I guess I will start. 

Mr. CASTLE. You will have to be brief. I apologize for that. 

Mr. HARRIS. It is unlikely that there—my opinion is there is not 

a lot of systemic risk from private equity. There may be a lot of 

losses, you know, over the course of the next year or two, but not 

a lot of systemic risk. The reason for that is there is $1 trillion of 

dry powder that has not yet—that has been committed by investors 

but not invested into the private equity area. So there are highly 

leveraged transactions, but it is unlikely that they will require any 

kind of governmental support. 

Mr. CASTLE. Yes, Mr. Groome? 

Mr. GROOME. I would echo a couple of things. Number one, I do 

not think regulation in any form that I have ever really, truly observed, has taken a huge step toward preventing systemic risk in 

and of itself, which is why in my earlier remarks I said it is the 

informed conversation, it is informing supervisors, getting supervisors to understand the business models that they are supervising 

and be more engaged, whether it is a hedge fund, a bank, an insurVerDate Nov 24 2008 17:52 Sep 24, 2009 Jkt 051588 PO 00000 Frm 00035 Fmt 6633 Sfmt 6633 K:\DOCS\51588.TXT TERRIE
30 

ance company, a pension fund, or what have you. That informed 

supervisor and the behavioral changes they can have on the managers of a supervised institution through their ongoing conversations, by asking intelligent, good questions, will change the behavior of those institutions much more than any set rules or regulations will do. 

Unfortunately, I think in the last 15 years, the model has moved 

much more to a rule-based system in a number of jurisdictions, not 

just the United States, and not just hedge funds, but banking and 

elsewhere. And when I have gone to some of those supervisors and 

said, ‘‘Why aren’t you—still have someone who is 45 or 55 years 

old and who has been for 15 years involved with one institution 

and understands that institution so well that they understand it 

better than the CEO and the CFO?’’ And the answer seems to be 

that they have changed their models consciously because they 

think there is no system, quite frankly, in the world, that can prevent outright fraud. 

And so what they get criticized for, as supervisors, are frauds 

and missing frauds. But they don’t get credit, in this person’s 

words, who is a longstanding bank regulator in a G7 country—he 

said, ‘‘We never get credit for the institutions that never failed. We 

never got credit for telling the board, ‘That CFO needs to go.’ We 

never get credit for that. We only get criticized when somebody 

committed fraud far afield from anything we ever had systems to 

deal with or supervisory capacity to understand.’’ 

So we need to be careful, and in my opinion, I have argued for 

a number of years, we need to hire better supervisors, we need to 

pay them more, we need to give them better systems. The playing 

field is not level. The institutions they are trying to monitor and 

supervise are so far ahead of them that they are always playing 

catch-up. And it is supervision, not regulation, which will help prevent systemic risk and financial stability. 

Mr. CASTLE. Well, thank you all. Just a final comment, I don’t 

disagree with you, Mr. Groome, on that, but we as a committee are 

sort of scouting at how we better can handle systemic risk, so we 

are very interested in the insights with respect to that issue as 

well. 

I yield back, Mr. Chairman. Thank you, sir, for the extra time. 

Chairman KANJORSKI. Thank you very much, Mr. Castle. Now 

Mr. Lynch. 

Mr. LYNCH. Thank you, Mr. Chairman, and I want to thank the 

witnesses for their willingness to help the committee with its work. 

I do agree with one part of what was just said, and that is the 

government hasn’t had the ability to keep up from the regulatory 

side. We are basically operating with the same set or rules, the 

Constitution, and statutes that—we may get rid of the powdered 

wigs up here, but we are still acting and dealing with a lot of the 

same issues we have for the past 100 or so years. 

I do want to say, though, one of the victories, I think, of regulation was the FDIC that stopped a lot of bank failures and created 

a lot of stability in that market. And I actually see the opposite, 

Mr. Groome, that we had Glass-Steagall and we had a somewhat 

borrowing, solid banking industry, and then we got away from that 

31 

through Gramm-Leach-Bliley, it was a deregulation model that led 

us into this mess. 

And as well, there are a couple of things that play here. One is 

the opacity of some of our institutions and hedge funds especially. 

And complexity. The complexity of the instruments that people are 

investing in now have just made it very difficult. I am on the Oversight Committee as well, and trying to make heads or tails out of 

these collateral debt obligations and other very complex derivatives, it is a pretty tough task for the average person, I would say. 

That much being said, I think that there is a role for responsible 

regulation here, and I think all hedge funds should have to at least 

register to say, ‘‘Hey, we are in this business, this is what we are 

doing.’’ And regardless of their size, I think everybody ought to step 

up and say, ‘‘We are in this business and we are doing this in a 

public market.’’ 

One of the things that kind of ticked me off was the President’s 

Working Group asked for recommendations. They set up a couple 

of panels to offer recommendations about going forward. And most 

of their recommendations—all of them, actually—just talk about 

market discipline and say folks have to understand more about 

what they are investing in, they have to do this, they have to do 

that, and put the onus on the—it is basically buyer beware. 

And at the same time, you do have all this complexity and opacity. You know, you really can’t get the information as a market 

participant on a lot of this stuff. And a lot of these pension funds 

that are representing regular people, their fiduciary responsibility 

is there of course, but their ability to conduct this research is highly problematic. 

How do we get at that? Look, you have a bunch of hedge funds 

and market participants who take major positions, highly leveraged 

on one side of a trade, and it goes bad. And they all scramble to 

liquidate their positions and we have a major problem. This is a 

$1.4 trillion industry, and you are going to have definite systemic 

risk when those things happen, as we have seen. How do we get 

at that with just market discipline, be careful of what you buy? 

Mr. CHANOS. Well, let me take a shot at that. Again, I have pension fund clients and I have endowments as clients, and I have 

high net worth families as clients. And I have to tell you, they are 

some of the most sophisticated investors who come in regularly, 

look at our books, look at our positions, ask questions, do the kind 

of work that I think you would hope that people do from the investor side in our fund, and they do a pretty good job. 

I don’t have all my clients do that, but the vast majority, representing over 90 percent of my assets, do that regularly and do 

a good job, because in many cases they are required to on behalf 

of their fiduciary clients. So I think it does happen. It does happen 

in a— 

Mr. LYNCH. Well as someone who sat on a pension fund as a 

trustee with the ironworkers, I can tell you there are a lot of funds 

out there that folks meet once a month for about an hour, and they 

are representing other people in the pension fund, and sure, you 

know what percentage is going into hedge funds, but trying to figure out what the hedge fund—and actually, hedge funds do provide 

a valuable opportunity for some of these pension funds. 

32 

I don’t disagree with that, but what I’m saying is that fiduciary 

responsibility to understand what the investment is and what the 

value of the assets are and how those values were arrived at, that 

is a deeper understanding than I think the great majority of these 

pension funds have. 

Mr. CHANOS. Most hedge funds allow their investors the right to 

do that. If that work is not being done, it is not the fault of the 

hedge fund industry. It is their— 

Mr. LYNCH. Right. I understand. 

Mr. CHANOS. It is the pension fund advisors you should be talking to. 

Mr. LYNCH. I’m sorry. Mr. Groome? 

Mr. GROOME. I would echo that. Our client base is also very 

heavily from the pension fund side of the world, and they come in 

and have stringent due diligence sessions on a very frequent basis, 

and they get all the information they ask for. We provide it extensively in advance, and when they come in, they have free reign of 

asking what they wish to receive and they will receive it. And we 

know that if they don’t, they have the ability to take their money 

and go elsewhere. 

I’m not sure if you were here for our statements, but just to repeat, in February, we came out and stated very clearly that our organization, AIMA, supports registration, but registration alone is 

not the answer. It really requires a transparency improvement, and 

that itself will lead to an informed dialogue, an intelligent dialogue, 

between the supervisory authority and the hedge fund manager 

that is being supervised and has registered. 

Therefore, to complement that, we also recommended periodic reporting by larger hedge funds. We can debate, as we have, about 

what larger means and where that cut-off should be, but I think 

if that number is too low, if that cut-off is too low, the entrepreneurial nature of the industry will be endangered. The economics 

of a small hedge fund will be challenged to meet some of the standards we are talking about putting in place or the reporting requirements we are proposing to put in place. But transparency is important—market discipline without transparency doesn’t work. 

Mr. LYNCH. All right, we agree. 

Mr. GROOME. Market discipline needs transparency. 

Mr. HARRIS. Just to follow up on your comments, there is always 

a resource issue on some of these funds that you are talking about. 

So I agree that many times, it is—the hedge fund is perfectly willing to show you their books. There is just nobody on your side to 

look at them, and that has to be stated. If you go to a fully 

resourced fund like ours, we require full transparency, we have access to the books any time that we want, we take advantage of 

that. 

I am on the President’s Working Group, and we are requiring all 

of our hedge funds to be fully compliant with the President’s Work 

Group by the end of the year; 37 of the 45 are already compliant. 

And the high water mark issue that is associated with pension 

funds will take some of these pension funds out the game and the 

market will work its way through back to a response that will 

bring us back into parity. 

33 

Ms. WILLIAMS. Could I jump in for a minute? I would also like 

to echo that we found in our report when we looked at pension 

fund investment in hedge funds and private equity that resources 

were an issue. But I think you have also heard on this panel the 

issue of hedge funds providing any information that is requested. 

So that requires knowing what information to ask for and then 

knowing what to do with the information once you get it, and we 

found that to be a challenge for many smaller pension funds. 

Mr. LYNCH. I agree. 

Mr. BAKER. Mr. Lynch, if I may join in? 

Mr. LYNCH. Sure. 

Mr. BAKER. Ten years ago or a little over, the first President’s 

Working Group report came out. A Member of Congress took that, 

turned it into the Hedge Fund Transparency Act, had a hearing, 

and everybody came down from the MFA and opposed it. I was the 

Congressman who had that bill. 

Ten years subsequent to that, we now have just finished—at 

great expense and a lengthy process—incorporating all the President’s Working Group sound practices—recommendations into our 

own sound practices document. That in itself is not of note. What 

is of note is that we send that out broadly to all investor groups, 

to pensions, to individual investors we can identify, and say to 

them measure your potential investment opportunity against these 

minimum standards. You can go beyond what we recommend, but 

if there is an aberration in what we recommend—and they are significant, I would be happy to provide them to the committee, they 

are on our Web site. 

We are also working very closely with AIMA on an international 

harmonization of those sound practices so that there is a global 

standard. And there are some regional disparities where we won’t 

ever come together, but in large measure what we are doing is in 

response to our investors. They are demanding these standards of 

disclosure and we are providing them because it is what the market is asking for, and we believe them to be very high standards 

of responsible conduct. 

Mr. LYNCH. Fair enough. Thank you for your forbearance, Mr. 

Chairman. I yield back the balance of my time. 

Chairman KANJORSKI. Thank you very much, Mr. Lynch. See, we 

try and be fair up here. 

Mr. Posey for 5 minutes. 

Mr. POSEY. Thank you, Mr. Chairman. 

It is my belief based on observation and experience that government will never get ahead of the leading edge of technology or creativity. I just think it is an unrealistic expectation. But when that 

creativity or technology is misused, I think that is when we have 

laws like racketeering laws that you would come in and set the 

record straight on what is an acceptable standard of use or misuse 

of that creativity or that technology. I think the standards, overall, 

obviously is are you treating the people who are paying you or are 

you treating the public fairly? I think that is a pretty well recognized standard that could be used and should be used. 

And as an example I think somebody referred earlier to how the 

public reacts to different laws. You know, if you are late for your 

plane flight and there is a 5-mile stretch that if you do the speed 

34 

limit you will miss the flight, if you exceed it, you will probably 

make the flight. If you know the police are all over that road and 

they run radar regularly, you are probably going to miss your 

flight. If you know nobody ever gets a ticket on that road, you are 

probably going to make your flight. 

And so I think the public expects us and the creative people and 

the techie people expect us to set a boundary, and I think we have 

kind of failed to do that. I use the example, and I think a couple 

of you mentioned it in your writings, I know Mr. Chanos that you 

did, of Mr. Markopoulos going to the SEC almost a decade ago. 

Now they were empowered to do most of the things I believe you 

said we needed to look out for, but they failed to do it. They had 

1,100 lawyers who filed an average of one case every other year, 

and so it is just like having no police on the highway. You can expect people to speed if they know that there are no consequences. 

And the chairman said before that we need to have people and 

be able to pay people to meet the standards that we expect to challenge, but I think it is almost going to be impossible to try and get 

ahead of the technology and the creativity curve. Again, I think we 

need to have laws in place for the abuse of that stuff. And to my 

knowledge, after the Markopoulos screw-up and $70 billion evaporated or however many it was, I don’t know that anybody was even 

reprimanded, I don’t think anybody was fired. 

I mean if it was any of your companies or any of our companies, 

all senior management would have been gone in 24 hours. But 

somehow it is just acceptable to go along and not do your job up 

here, and the consequences are that we are looking to point fingers 

and over-regulate down the road in the future. If my logic is bad, 

I would like one of you to point it out. 

Mr. CHANOS. It gets back to my comment about smart regulation, 

not more regulation. I mean we have a body of people who are trying—I think trying their best, but in many cases are overmatched 

or just don’t have the financial experience to look at what they are 

regulating. Quite frankly, we have an army of attorneys trying to 

oversee an army of market participants, and there are some flaws 

in that. 

Mr. POSEY. My thought was not that we try and regulate how 

you build a car, if it is capable of exceeding the speed limit, but 

if in fact you use it to exceed the speed limit you abuse people, just 

like Enron did or just like other people have. If people have been 

abused in this process and haven’t been dealt with fairly, there 

should be consequences for that. 

Don’t try and reinvent the car, don’t try and reinvent the wheel. 

Enforce the law, enforce a standard of fairness. And whether the 

public or individual clients have been dealt with fairly, I think that 

is a reasonable standard, a bottom line standard, that we should 

have the Justice Department, the SEC, the FTC, and everybody 

else on top of right now to start— 

Mr. CHANOS. But my point is they don’t even see the crimes. One 

of the ideas that has been bandied around in our industry more 

and more refers to the ranking member’s, I think, concern earlier, 

is in law enforcement, to use the metaphor, and the military, we 

have academies, we have colleges to teach our officers or law enVerDate Nov 24 2008 17:52 Sep 24, 2009 Jkt 051588 PO 00000 Frm 00040 Fmt 6633 Sfmt 6633 K:\DOCS\51588.TXT TERRIE
35 

forcement people the latest in law enforcement techniques or military theory as they go on in their career. 

We need this in our financial area as well. We need financial 

boot camp. We need retired hedge fund managers and trainers to 

come in pro bono—and a lot would do it, quite frankly—to help 

teach junior regulators, and middle and senior level regulators how 

to detect fraud, how to detect malfeasance on a trading desk, how 

to spot some of these things. There are patterns that have occurred 

down through history that just, I think, over and over and over 

again our government regulators miss. Again, smart regulation, not 

more regulation. 

Mr. POSEY. Mr. Chairman, if I can just follow up? 

Actually, we did that in another State. We had a problem cracking down on fraud and the excuse was we couldn’t get competent 

people because they get hired away as soon as we train them, and 

so instead of going out and just searching these people we have 

started training our own, and I think that is a real good suggestion 

maybe that we might take under consideration and think about 

that. 

Mr. CHANOS. I have people in our industry who are coming forward to me and my organization to say they would volunteer or 

they are retired people, and would be happy to do that as a public 

policy. 

Mr. POSEY. That is a good idea, thank you. 

Chairman KANJORSKI. That is an excellent idea. Can you give us 

a little two-pager on that? 

Mr. CHANOS. I would love to submit something on that. 

Chairman KANJORSKI. I appreciate it. 

Mr. GROOME. Mr. Chairman, if I may? 

Chairman KANJORSKI. Yes. 

Mr. GROOME. You might also reach out on the same topic to the 

FSA in the U.K., because they too reach out to the industry and 

have people come into the FSA for some time period where they 

benefit from their knowledge and understanding of the industry. I 

would endorse everything that Jim just said, but rephrase it differently. We really want to have supervisors who understand what 

the right questions are. It is understanding the questions even 

more than the answers that are really, really important. 

Chairman KANJORSKI. Before I— 

Mr. BAKER. Mr. Chairman, if I can jump in just at the tail end 

of that process? I just wanted to volunteer that the MFA staff will 

be meeting with SEC staff next week on exactly that discussion, 

how to improve the accuracy of their examination process. We have 

found that all too often they spend an inordinate amount of our 

time for no apparent end result. We think they can get in and get 

out with the right tools much quicker and go to the material facts 

that really make a difference, and we have voluntarily reached out 

to the agency to help in that effort. 

Chairman KANJORSKI. That is pretty good, but Mr. Baker, may 

I make a suggestion that perhaps we have staff from the committee 

or even members of the committee knowledgeable about these conversations participate because what you may put in their hands 

never tends to get here. In reality, we are the ones who are going 

to write and charter what has to be done in the future, so if you 

36 

think about it, maybe we could have a better line of communication 

by getting some of—I don’t think that violates any separation of 

power. 

Mr. BAKER. Mr. Chairman, subject to appropriate ethical oversight, I will always say yes to a chairman. 

Ms. WILLIAMS. I have one thing to add about SEC. SEC, when 

they first required registration, they had hedge fund—members 

from the hedge fund industry teach OCIE and enforcement staff 

when they first moved toward registration that was ultimately 

turned over by the court. So they have been engaging in some of 

this type of activity in the past. 

Mr. HARRIS. I would just counsel you that when you do that, you 

need to discriminate between two types of risk. One type is risk 

monitoring, which frankly is a huge distraction to what you are 

doing. The other type, which is for lack of a better term I call bullet 

to the brain risk is what you need to focus on, and that list of questions is probably no more than ten. It is not 100. And when you 

go beyond 10 or 12 key questions to 100 or 200 or 300, you diminish the effect of the 10 that really matter. 

Chairman KANJORSKI. Very good. Before I recognize Mr. Foster, 

I think we have had him get ready to start several times, but I am 

not trying to block him. 

What I do not understand—and if we could hear from someone 

on the point, later on after the session—about the Madoff disaster, 

is that with the amount involved and 13,000 victims, and most of 

those victims were very sophisticated people, how did due diligence 

fail? It shocks my understanding of what we can do to improve the 

situation of examination and knowing what is going to happen 

given the size and sophistication of the victims. So if you could just 

give that— 

Mr. HARRIS. May I respond? First of all, to give an institutional 

perspective, I have been doing this since 1985. I have run three or 

four of the biggest funds in the country. I had never heard of 

Madoff in my entire life, so he was not operating in the realm 

where this kind of due diligence was being done. 

The individuals that you are citing are sophisticated, but they 

are not financially sophisticated. This was country club, you know, 

this guy does great, put the money with him. There was no—as far 

as I can see, and I have just read what you have read in the papers—there was no due diligence being done. He was operating outside the system with individuals mouth to mouth in a long-term 

Ponzi scheme. People like me who operate in an institutional 

world, he never came across our doorstep once. 

Mr. GROOME. Or, to say the same thing in a different way, we 

had someone actually approach our organization several years ago 

and ask us if we knew that fund, knew that person, and if we 

would on their behalf meet them. And because it was an existing 

client in a different part of the business, they did so. Prior to the 

meeting our due diligence team was told, ‘‘These are the questions 

you are allowed to ask,’’ and we said, ‘‘We are not interested in the 

meeting.’’ So the signals can be quite clear. This is why my point 

about knowing the questions is much more important sometimes 

than the answers. 

37 

Chairman KANJORSKI. I am tempted to go on, but I am going to 

stop it right here and say Mr. Foster, you have been kind and diligent to give us the time. You are recognized for 5 minutes, or more, 

as the case may be. 

Mr. FOSTER. I guess the first question is for Mr. Baker. You had 

characterized the hedge fund industry as a relatively small $1.3- to 

$1.5 trillion industry with leverage in the range of two to three, industry average. And I was wondering, what is the notional value 

of all the swaps and off balance sheet obligations in the hedge fund 

industry? 

Mr. BAKER. It would be difficult for me to give you an accurate 

estimate, but I will try to get back to you subsequent to the hearing. 

Mr. FOSTER. Well, can you assure me it is under $10 trillion, for 

example? 

Mr. BAKER. I won’t make a representation to you this morning 

until I do some analysis, but I will be happy to get back, and of 

course forward it to the chairman and the ranking member as well. 

Mr. FOSTER. I guess it was one of the—I guess it was Ben 

Bernanke and others—have made the analogy between AIG is a 

healthy insurance company with an unregulated hedge fund grafted onto it, and from that point of view, the collapse of AIG is sort 

of a preview of what the collapse of a big hedge fund would look 

like. And I was wondering if you have a reaction to that analogy 

and is it a fair— 

Mr. BAKER. I was hoping that the chairman was misquoted and 

that he was hoping AIG was a hedge fund because its losses would 

not have been so precipitous had they been exercising any standard 

of due diligence in their investment activity. 

No, in a serious mood, I took affront for our industry that we 

would be characterized in such a fashion. The closer one gets to the 

taxpayer’s wallet, I understand the regulatory encroachment. But 

hedge funds raise their money, they invest their money, and their 

investment advice is on the table with their investors. And if the 

fund makes money, sure, they make money. If they lose money, 

guess what, they lose money. And if the unfortunate event occurs 

where they go out of business, strange people show up and sell 

your furniture. That is the end of the story. There is not tax— 

Mr. FOSTER. Which works, that is a model that works, as long 

as they don’t have off credit sheet obligations that are enormous 

compared to their actual assets. Then there is huge counterparty 

risk. Can you assure me that there are no AIG Financial Products 

out there in the guise of the hedge fund industry? 

Mr. BAKER. And to date there has been not one— 

Mr. FOSTER. I understand. I understand they have not yet blown 

up. The question is, can you assure me that there is not an equivalently violent explosion waiting in the wings? 

Mr. BAKER. If the question is, do I believe there will be some failures in the future that I cannot name? It is a probability. Will 

those future failures result in some systemically significant event? 

That is very unlikely. 

Mr. FOSTER. Okay. Let’s see. Mr. Groome, you said you supported periodic reporting by large hedge funds, and I was wonVerDate Nov 24 2008 17:52 Sep 24, 2009 Jkt 051588 PO 00000 Frm 00043 Fmt 6633 Sfmt 6633 K:\DOCS\51588.TXT TERRIE
38 

dering what exactly periodic might mean. We had some discussion 

of large. 

We have learned in the collapse that the timescale for the collapse is hours or days, and so it seems to me that periodic reporting has to be the same sort of thing that happens internally to the 

investment banks that still exist, and also, I presume, large hedge 

funds where they net out the enterprise-wide exposure to various 

things almost on an hourly basis. And I was wondering, is there 

anything short of that sort of very frequent reporting that will actually allow a systemic risk regulator to do its job? 

Mr. GROOME. Yes, I think so. In the conversations we have had 

in this country and elsewhere with our membership, we have heard 

everything from monthly to annual, and that includes all parts of 

that spectrum. Annual is clearly not enough, monthly is probably 

too frequent for the cost involved and the ability of the supervisor 

to analyze it and use it effectively. And so what I have tended to 

hear is people gravitating towards quarterly or maybe semi-annually, but that tends to be the timeframe people are talking about. 

Mr. FOSTER. Now why then do investment banks and large hedge 

funds do it at least daily? Why is it not useful for something that 

is responsible for the stability of the whole financial system, why 

is that a less stringent requirement than just for the survival of an 

individual firm? 

Mr. GROOME. Well you could—I mean I would phrase it this way. 

Systemic risk doesn’t occur overnight. It builds up over time as it 

has in our system over the last several years to the detriment of 

what we experienced in the fall of 2008. And in Jim’s business, for 

example, a number of hedge funds dedicated to the shortselling effort were the canaries in the coal mine as far back as 2006 telling 

us exactly what those risks looked like and executing transactions 

to demonstrate their disbelief in the valuations of certain bank 

portfolios and mortgage values. 

The system we are contemplating, we are proposing, we have discussed with supervisors—we think it has two benefits. It has a national benefit to, say, the SEC or the FSA, where they can identify 

outliers in the system. They can look across strategies and see consistency as they usually will among the approach to that based on 

liquidity, leverage, and other risk factors. To the extent somebody 

stands out, that is where Ms. Schapiro or others have said that it 

would be very useful to take a rifle approach, and not have a shotgun approach, and be able to identify outliers. 

On the international stage, the Financial Stability Board, as well 

as the Treasury and the Fed in this country, would take that information and monitor developments over time and asset classes, and 

you can clearly see the build-ups of risks, as we did see and everyone has talked about for years in the structured credit and the 

mortgage markets, which ultimately did explode. 

Mr. FOSTER. So you don’t believe it is a logical possibility for a 

systemic risk to build up on the timescale of days? 

Mr. GROOME. Well, I wouldn’t say it is impossible, but I cannot 

contemplate it right now. What I am saying is the risk in the system doesn’t just generate over the course of hours or days. Risk 

builds up to such an extent that you are exposed to market disruptions, and we have seen that occur, time and again. 

39 

Mr. FOSTER. I yield back. 

Chairman KANJORSKI. Thank you, Mr. Foster. Mr. Royce of California for 5 minutes. 

Mr. ROYCE. Thank you. 

I was going to ask Mr. Baker, you had mentioned in your opening remarks about the extensive trading rules and reporting requirements that hedge funds are subject to under existing law. As 

I understand it, on top of that, the majority of hedge funds do not 

register voluntarily with the SEC and I think it is about threequarters of the assets that hedge funds have in their portfolio. But 

could you expand on the requirements themselves? 

Mr. BAKER. Yes, I would be happy to provide you and the committee with the document that gets distributed to an office when 

the SEC is about to visit. The historic document is about 20 pages, 

it is very extensive in the disclosures that are required. It is not 

name, rank, and serial number only, and that is the beginning of 

the process. Obviously, the agency, after entering a firm, as it discovers areas that it has interest, will then expand the scope of 

those inquiries as it deems appropriate. 

I mentioned earlier in the hearing to the chairman that it is not 

uncommon for those examination processes to extend months. In 

fact, longer than a year is not that unusual, so that contrary to 

most public perception about the current oversight system, voluntary though it is, it is very extensive, very time consuming, and 

very difficult for the firm to be responsive to all of the questions 

that are raised. 

That being said, others on the panel have indicated that SEC resources are very limited and that the experience of the examiners 

all too often is not appropriate for the business models they are examining, and we believe that leads to unproductive work on the 

government side, and that a sharper, focused examination trigger 

and then a sharper set of skills being involved in the examination 

process would yield benefits to everyone. 

Mr. ROYCE. Let me ask the witnesses this. We witnesses some 

gross negligence on behalf of the SEC, I guess is the way you would 

view it in terms of the Bernie Madoff circumstance. And Mr. 

Markopoulos testified here and we had an opportunity to talk with 

the investigators for the SEC. Do you believe that the SEC and 

other financial services regulators are currently equipped to conduct examinations and other necessary regulatory steps? 

To me, one of the interesting aspects of this is the amount of 

market discipline and due diligence that you see in institutions— 

and I guess Britt Harris might have some observations on this with 

the pension funds—the amount of examination you do—I opened 

my remarks this morning just contrasting this. You are leveraged 

two or three to one. Fannie Mae or Freddie Mac, the Government 

Sponsored Enterprises that we had oversight with, we allowed 

them to go into arbitrate—pushed them into leveraging 100 to 1, 

and at the same time Congress, against my advice and certainly 

against Mr. Baker’s, did not heed the request of the Fed when they 

said these need to be regulated for systemic risk, you have to 

deleverage these portfolios. So here you are contrasting leveraging 

2 or 3 to one to leveraging 100 to 1, which was done under, perhaps, the most regulated environment. 

40 

But with the regulation by Congress came something else, came 

also the ability of Congress to direct those investments, to set those 

goals for subprime, to set those goals for Alt-A loans, to set those 

goals in terms of who you are going to loan to, and to build up the 

risk between the over-leveraging and the type of activity. 

And I suspect that one of the concerns is always with congressional oversight comes the assumption that the regulators that are 

involved in this have the expertise, and I guess one of the real 

questions, looking at the SEC as a result of the investigations and 

the hearings that we held, this was a sobering hearing when we 

had Mr. Madoff here with the loss of $65 billion over something 

that the SEC failed to catch. Any observations on that? 

Mr. BAKER. Mr. Royce, I would jump in and say from a market 

discipline perspective, the regulatory team should be viewed as— 

I hope this is not an inappropriate characterization—as the law enforcement officials who get called when the act is obvious to everyone. In my home State, we have a lot of neighborhood watch subdivisions where the community itself reports suspicious activity to 

law enforcement, because they can’t be everywhere all the time. 

That is the function of the private market in the financial world. 

When Mr. Chanos engages in his work and determines that values are improperly inflated, he takes a financial position on that 

matter. When the pension fund, Mr. Harris, does his examination, 

he goes through a series of sophisticated steps to make sure that 

when he writes the check for his pensioners dependent on his judgment, that he has asked all the right questions and gotten responsible answers. 

That is the neighborhood watch response. Sure, you do need to 

have some police around, but they can’t be in every neighborhood 

on every day to stop every violation when you are trying to get to 

the airport on schedule. So I think the responsible way to balance 

this is to rely on a strong neighborhood watch program, and where 

market participants do the due diligence. 

And frankly, I didn’t get in on the Madoff matter and how it got 

that far advanced. Members of our association looked into the 

Madoff matter and voluntarily decided this wasn’t a place for their 

client’s money to be placed. There were a lot of warning signals, 

but the attractiveness of inflated returns over a long period of time 

and having such—you may remember from the Fannie and Freddie 

days, a steady Freddie label. Anybody who promises no volatility 

on returns for a decade or more, you need to be careful. And just 

that alone should have been sufficient for people to have exercised 

better judgment. The man was a great fraud, one of the best ever, 

and he made up the trades. He reported non-factual figures. Everybody did what they should have done appropriately, but the man 

lied, and the result is a lot of people got hurt. 

Mr. ROYCE. Thank you, Mr. Baker. Thank you, Mr. Chairman. 

Chairman KANJORSKI. We still have one holdout here. Mr. 

Himes, we are going to give you your 5 minutes too. 

Mr. HIMES. Thank you, Mr. Chairman, and thank you very much 

to the witnesses. Assuming those doors stay closed, you are less 

than 5 minutes away from being done. 

I appreciate your testimony. I have a small question and a big 

question. I appreciate much of what you said. I take small excepVerDate Nov 24 2008 17:52 Sep 24, 2009 Jkt 051588 PO 00000 Frm 00046 Fmt 6633 Sfmt 6633 K:\DOCS\51588.TXT TERRIE
41 

tion though. There was a lot of discussion about the average level 

of leverage in the hedge fund industry, and when the witness said 

it—and I forget who said it—I was reminded of that old song never 

ever try to walk across a river that is on average 4 feet deep. We 

do not care about the average. We obviously care about that institution which once every year or once every 2 years is going to get 

itself into trouble, so that is what we are focused on here. 

My small question is, were this simply an industry of high net 

worth investors, I would be a lot less worried than I am. It is an 

industry in which we have seen pension and other public monies 

come in where there is a whole set of issues there. I want to set 

that aside. It is a little beyond the scope of this hearing. But what 

really does worry me are those entities that are employing the kind 

of leverage that we saw with long-term capital management and 

whatnot. 

So my question is this. I’m not convinced that assets under management is necessarily what we want to watch. How do we best 

watch those entities that are taking on a lot of leverage? And I will 

ask for maybe one or two responses because I have a larger question behind this one. What is the number? Do we watch the banks, 

do we watch a set—what is the number at which we should make 

a cut off of who we watch for this purpose? 

Mr. CHANOS. Well one of the ways in which the Fed, both Chairman Bernanke and Chairman Greenspan, pointed out was the one 

way to monitor leverage in the hedge fund industry is to be looking 

at the prime brokers, the breaks and brokers that domicile their 

accounts. They typically are in banks and brokers, not in trust accounts. So you can in fact monitor from the systemic point of view 

from the other side of the telescope the amount of leverage relative 

to equity in major accounts, in the top 20 percent, with 80 percent 

of the assets, for example. 

There are ways to get at this from where the accounts are 

housed, a more practical point of view. You still might miss various 

forms of hidden leverage or derivative exposure, which was alluded 

to earlier— 

Mr. HIMES. I would like to come to that, but just—and in fact 

I want to come to that right now—but just ballpark figure, give me 

a sense, give the committee a sense, if we are really after those 

hedge funds capable of employing the leverage that produces a systemic risk, order of magnitude, are we talking about 10, 100, 1,000? 

How many hedge funds are we talking about? 

Mr. GROOME. Well, let me try to answer that. In my testimony 

I said that we proposed $500 million as a possible cut-off for registration, and I think that actually needs some real thought for ongoing reporting or standards to be required. And I gave an example. If you change that to $1 billion assets under management by 

the hedge fund manager, you are still capturing 311 hedge funds 

worldwide, by our count. Approximately 215 of those are in the 

United States. That group would represent 80 percent of assets 

under management, so you get a very full picture of the industry. 

Two comments, I guess, qualitatively. If you move that number, by the way, to $2 billion, you really only go down to about 200 

hedge funds and 70 percent of assets, so you don’t get a lot of bang 

for your buck by that move. 

42 

Mr. HIMES. Thank you. Okay, a larger question, and I direct this 

to Mr. Baker. Mr. Baker, I’m also interested in synthetic leverage, 

and I want to pick up on an example that you used. You go long 

in computer company A, short in company B. Let’s take a huge position because we have leveraged out all but the risk that we want 

to take. Well, as you and I know, occasionally you get whip-sawed 

and you are short and computer company B rises, and your long 

falls and you are now in a position where you are effectively taking 

on an awful lot of synthetic leverage. 

I really worry about that, partly because even though I spend 

time in the industry, I’m not sure I can identify all of those generators of synthetic leverage, if you will. So I’m going to ask you, I’m 

wondering if you have done any work, your organization has done 

any work identifying those areas, and in the very limited time that 

remains, can you talk a little bit about those areas where it is not 

bank lending, but it is significant leverage? 

Mr. BAKER. Sure I can. We don’t have any studies particularly 

on the point, but we can certainly provide you with a more detailed 

response. The quick answer would be don’t forget the manager’s 

money is on the table with his investors. That is an extremely important factor in taking outsized risks. 

Secondly, where you do have bank lending, the Fed has supervision over the bank holding companies, which is a way in which 

Mr. Bernanke and others can get access to look exactly inward at 

those activities and make judgments about risk. Ultimately I think 

it is the management of the entity and his responsibility to his investors that attempts to seek some sort of operational balance. 

On a given day, yes, people are going to lose money. I go back 

to the observation that the government role traditionally is not to 

preclude business failure, it is to make sure that a failure of an entity doesn’t affect innocent third parties, and I think we can do that 

with appropriate operational standards of conduct. 

Mr. HIMES. Thank you, and I see I am out of time, but if your 

organization, perhaps working with the other witnesses, could generate nothing more complex than perhaps a list of mechanisms that 

can create, if you will, synthetic debt of synthetic credit exposure, 

that would be very helpful. 

Mr. BAKER. We will get back to you soon. 

Mr. HIMES. Thank you very much. 

Chairman KANJORSKI. I think we are down to Mr. Grayson now. 

Mr. Grayson, for 5 minutes. 

Mr. GRAYSON. Thank you, Mr. Chairman. 

I think the lesson of the past year has been that we have to try 

to avoid systemic risk, and I would like to explore with some of 

you, in the time that we have available, what the substantive rules 

should be to prevent institutions from creating risks that lead to 

taxpayers having to shell out $100 billion and more to AIG in one 

instance, and many other instances that we have seen from the 

past year. 

So I would like to know not simply about, honestly, cliches like 

best practices, but rather, what the limits should be. How much leverage is too much, at what size does an institution become counterproductive because of the institution instituting systemic risk 

43 

that puts the whole system at risk? Tell me what you think the 

limits should be. Let’s start with Mr. Baker. 

Mr. BAKER. I can’t give you a direct response to your question, 

Congressman, in that simply an asset under management test isn’t 

really sufficient for the systemic risk concerns, in my view, that 

there are other elements to that conversation, as in the prior conversation discussing leverage. A smaller firm, highly leveraged, can 

have just as much effect as a larger firm that is not. The interrelatedness of counterparties is certainly very important in this current 

environment. 

My members spend a lot of time analyzing the financial stability 

of the broker/dealers in which we are engaged. That didn’t used to 

be the case. Everybody is watching everybody is the best way to describe the current market condition, because apparently innocuous, 

not significantly large by any standard asset under management 

measure can become systemically significant in the right set of 

market conditions. 

Mr. GRAYSON. All right, let’s assume that there are a number of 

different variables that need to be factored in. Of course, making 

it sound complicated often leads to inaction. But let’s assume that 

we have identified an institution that poses systemic risk. What 

would you do about it? 

Mr. BAKER. Well, if I was Mr. Chanos, I would probably short 

him. No, I’m kidding. 

The end consequence of this question is one that has plagued the 

Congress for 25 years. We have debated what actions would one 

take if you identify a potentially harmful event. Who should make 

this judgment, and what authority should they be given to act in 

that consequence? There isn’t an easy answer to what you are posing in that—I will put it in this context. 

If you went back prior to LTCM, LTCM never had back-to-back 

2 days of trading losses. They were run by Nobel laureates. They 

took money for 3 years, and don’t call them. They were having outsized rates of returns, and because of an unexpected Soviet currency crisis that no one could have predicted, they went bankrupt 

in a matter of a few days. How one could have gone back 30 days 

in advance of LTCM and given a regulator authority to forecast 

that and then decide what action should have been taken to preclude losses is a difficult question. 

Mr. GRAYSON. Is it really? I mean in the case you were mentioning, there was 100 to 1 leverage used with billions of dollars 

as their capital base. Don’t you think that would make most people 

a little nervous? 

Mr. BAKER. There were people lined up wanting to invest in 

LTCM that couldn’t meet their investment criteria. So I go back to 

Chuck Prince at Citi. As long as the music is playing, it is hard 

to quit dancing. And when you are having outsized gains to exercise caution, it is a very difficult thing. 

Mr. GRAYSON. Well, the right answer cannot possibly be to do 

nothing, so let’s go on to Mr. Groome, and if we have time Mr. 

Chanos, so you can tell me when big is too big. 

Mr. GROOME. Well I would—it is really a continuation of the conversation I had with Mr. Himes, in some respects. You can set a 

threshold for what, basically, is someone is going to provide inforVerDate Nov 24 2008 17:52 Sep 24, 2009 Jkt 051588 PO 00000 Frm 00049 Fmt 6633 Sfmt 6633 K:\DOCS\51588.TXT TERRIE
44 

mation to supervisors. But within that, you have to qualitatively 

understand the business model and ask the right questions. 

So for example, to specifically address your question, I would, if 

I were in the supervisory seat, think very differently, for example, 

within the hedge fund world about long/short equity funds which 

are active in very large, liquid markets, than I would think about 

much smaller hedge funds which are in markets where the margins of their trading activity are very tight, the liquidity of their 

assets are very sporadic, and therefore sometimes they may be 

highly leveraged, try to maximize what is going on in that environment. That to me as a supervisor would send off a greater signal 

of concern than just simply someone’s relatively large size. 

Mr. GRAYSON. But again, complication leads to inaction. Mr. 

Chanos, can you give us an answer? 

Mr. CHANOS. I will go out on a limb—100 to 1 in anything is too 

much. 

Mr. GRAYSON. I agree with you, but let’s try to explore that a little bit further. Why can’t we develop a system—or can we develop 

a system where we can say with reliability that an institution that 

poses systemic threat will be barred? Why haven’t we done that yet 

and what do we need to do to get to the point where that actually 

happens on a reliable basis? 

Mr. CHANOS. That is beyond my level of expertise, Congressman. 

I don’t know at what point someone with the authority to do a 

wind-down in a systemically important institution says, ‘‘I have to 

do it here,’’ based on just level of leverage versus, perhaps, incurred 

losses, or interconnectedness, which was also part of the LTCM 

problem. Again, it wasn’t just the leverage, which was, as you point 

out, considerable. 

And by the way, inter-reporting as well. Some of these entities 

gear up in between periodic reports and then gear back down, including current regulated entities like banks and brokers. 

So all these things are part of a mosaic of risk that my quip 

about 100 to 1, which I was serious about, only underscores that 

you need to see just how interconnected some of these entities are 

and how much additional leverage the herding accounts for. And I 

don’t know. I don’t know what the answer is for a systemic risk 

regulator or the Fed or the Comptroller of the Currency to come 

in and step in at some cutoff level. 

Mr. GRAYSON. All right, my time is up, but I think this is the 

fundamental question that is facing us right now. We need to have 

somebody who is willing to say enough is enough. Thank you. 

Chairman KANJORSKI. Thank you very much, Mr. Grayson. The 

gentlelady from California, Ms. Speier. 

Ms. SPEIER. Thank you, Mr. Chairman. 

I have an article from the Washington Post dated October 19, 

2005, which I would like to submit for the record, without objection. 

Chairman KANJORSKI. Without objection, it is so ordered. 

Ms. SPEIER. It is an article by Steven Pearlstein entitled, ‘‘Hedge 

Funds Get Tangled in Bad-Business Cycle,’’ and it underscores just 

a number of hedge funds that were in trouble back in 2005. And 

at the end of the article, he says, ‘‘with $1 trillion in assets, hedge 

funds have become a dominant force in capital markets, accounting 

45 

for as much as half the daily trading on the stock market, hundreds of billions of dollars in bank loans, and a healthy chunk of 

the profits of Wall Street brokerages. Federal regulators cannot 

guard against systemic risk to global markets if they don’t know 

what hedge funds are doing.’’ Now this was back in 2005 when it was only $1 trillion. Today it is $2 trillion. And I must tell you that I am not at all sanguined 

by your comments today that somehow registration is enough because I don’t think it is enough. This is very reminiscent of what 

Congress did with the Modernization Act when we prohibited the 

regulation of derivatives. 

So with that said, I would like the auditor, Ms. Williams, to tell 

us what kind of regulation you would recommend. 

Ms. WILLIAMS. I would really point to our regulatory framework 

that GAO laid out earlier in the year, that any regulatory structure 

needs to address several elements, and I will briefly note two. 

One is that it needs to be comprehensive. That is, in order to 

deal with all elements under a system-wide focus, the regulator or 

the regulators have to have a view of the entire system and all of 

the players in the system. So with hedge funds, what comes to 

mind is here we are dealing with a known unknown. We know that 

hedge funds are players in the market, but specifics about the 

hedge funds, the number, assets under management, as well as 

their strategies specifically and their impact on the market is 

largely unknown. If you dealt with some of the known unknowns, 

that would allow a systemic risk regulator to begin to focus on the 

unknown unknowns. 

I think getting information to the regulators that provide insight 

about hedge funds from their role as investors in the market is key, 

because that is what we are currently seeing with hedge funds. 

They are expected to be involved in bringing us out of the current 

crisis through TALF, for example. The markets have come to rely 

on them as investors. 

Therefore, it is important to know where they are investing because they can move their assets to different markets depending on 

what is going on in any particular market. They can move in and 

out of equities, they can move in and out of commodities futures 

and have impacts on those markets when they are there and also 

when they move to another market. 

Ms. SPEIER. All right, having heard that from the representative 

from the GAO, I would like to have each of you respond to whether 

you would object to that kind of regulation. 

Mr. BAKER. If I may, Congresswoman, I think the registration 

proposal, as I understand it, would provide much of the information, if not all—just to make sure I’m not overstating the case— 

that the GAO has indicated would be helpful for a regulator to 

make an informed determination about action that might be required. 

Ms. SPEIER. Let’s just go down the line, and then I have a further question for all of you. 

Mr. GROOME. We too have said that registration is not the end, 

that the second component of registration has to be better information gathering and periodic reporting, and we have been working 

over the last several months with people at the G20 and the FinanVerDate Nov 24 2008 17:52 Sep 24, 2009 Jkt 051588 PO 00000 Frm 00051 Fmt 6633 Sfmt 6633 K:\DOCS\51588.TXT TERRIE
46 

cial Stability Forum and authorities in this country sharing ideas 

on what that template should look like. And in fact, starting last 

week, there was an experiment undertaken, if you will, or a consultation with the FSA and 20 large hedge funds to get their feedback directly on what that template may look like, so our members 

are very open to starting to provide systemically relevant information to supervisors. 

Ms. SPEIER. All right, my time is going to be up very soon, so I 

think what I would like to do is just ask all of you this final question. Warren Buffett files audited quarterly financial statements. 

Would you be supportive of, as part of registration, a responsibility 

to do that, that were indeed financial statements that were audited? Just go down the line, and if you would respond. 

Mr. BAKER. I guess I should start. I would say that disclosure to 

a regulator, as long as it is non-public, we would provide the regulator with any information they would ask us for. 

Mr. GROOME. We would do the same thing. Our members have 

said they would support a periodic reporting system—quarterly has 

been mentioned as the appropriate deadlines, time period—to supervisors. We have also stated that on a confidential basis such information should be aggregated and shared on a broader level, such 

as the Financial Stability Forum, but obviously on a confidential, 

aggregated basis. 

Mr. CHANOS. I would agree with that. 

Mr. HARRIS. I would just say Warren Buffett doesn’t short, so 

that is where the non-disclosure is the most sensitive. If you were 

to go down that end—and I also would modify maybe what I 

thought I heard you say, because I think there are many people 

here who are for more—for proper disclosure at the right organizations. 

The problem with the comprehensiveness is you will dilute your 

effectiveness. You will be monitoring somebody who is much too 

small to make a difference and diluting your ability to monitor people who are large enough to make a difference. 

Ms. SPEIER. I think my time has expired. Thank you, Mr. Harris. 

Thank you, Mr. Chairman. 

Chairman KANJORSKI. Thank you very much, Ms. Speier. 

We have a few more moments. We are anticipating a vote. If 

there is no objection, do you want to continue for a few minutes? 

I have a few more questions myself. 

In the responses to some of the examiners earlier, I sensed an 

overtone that there was not a great deal of respect for the professionalism and success of the SEC. Is that correct, or in fact is 

there— 

Mr. CHANOS. I think they are trying hard, Mr. Chairman, I really 

do. And I think they are working hard and I think they don’t have 

enough resources, but it is not for lack of effort and not for lack 

of trying to do the right thing on behalf of the American people. 

But I think they are just over-gunned and over-matched. 

Chairman KANJORSKI. That is a good political answer, but is that 

the real—I mean you are sincere about it. I am sure you are, Mr. 

Chanos. 

No, the question I am asking though, is we are going to have the 

opportunity to do some patchwork in some of these areas that we 

47 

have discovered already lend themselves to systemic risk and other 

difficulties, and a lot of legislation is occurring to cover that patchwork. On the other hand, as we approach regulatory reform, we 

also have a great opportunity now, I think—and I am saying opportunity—to fundamentally have comprehensive reform. And I think 

one of the things I heard mentioned was the FSA in the U.K. It 

sounded as if there may be an opinion that they may be doing a 

superior job because of their structure being a singular regulator, 

having capacities to do things, perhaps look at systemic risk regulation because it is all under one context as opposed to our separate 

regulators. 

Do you think we should speed along patchwork legislation to fill 

the voids in the holes that we have already discovered, regardless 

of whether or not these are in conflict in some instances with longterm comprehensive reform? Or should we keep our eye on the 

long-term comprehensive reform to take us out of the 20th Century 

and bring us into the 21st Century, which I think I heard one of 

the witnesses talk about? Yes? 

Mr. GROOME. I would—my view on that, Mr. Chairman, would 

be to take your time and to come up with a comprehensive proposal 

and identify very clearly what these risks are that we are trying 

to address and how best to address them. And to repeat something 

that I said earlier, I think better supervision is welcomed. Increased regulation without better supervision tends not to achieve 

the goal. 

I believe I probably made the comment about the FSA. The FSA 

is also doing some self-examination. They have had difficult times 

with their banking system and elsewhere, and so there is some real 

self-examination going on there as well. And I think as part of that 

they are also working with the Bank of England and asking what 

is the appropriate division of responsibilities and coordination between those two bodies? So you might find there is a very similar 

examination going on. 

Chairman KANJORSKI. Just as a little add-on to that, I recently 

made a presentation in Prague to about a dozen members of the 

E.U. and about a dozen members of the Congress where we were 

trying to look at international regulation and the need for it. Are 

we significantly behind the curve by having to meet the needs of 

the global economy and dealing from a nation by nation basis of 

regulation, or do we have to speedily move to some international 

regulation? 

Mr. BAKER. I would suggest—and I know Mr. Groome can address this perhaps better than I—that there is considerable ongoing debate on the continent at the moment as to the measure of 

oversight and level of accountability that hedge funds should have 

there, and it has been a very contentious discussion lasting now for 

a considerable period of time. I don’t know that the current directive, which was issued just April 30th, that has come out will ultimately be adopted by the member states in the form in which it 

was proposed, but suffice it to say that they discussion of financial 

reform has been ongoing longer than it has here. 

And we are attempting, as MFA, to reach out to AIMA to harmonize those standards as best we can suggest to policymakers, beVerDate Nov 24 2008 17:52 Sep 24, 2009 Jkt 051588 PO 00000 Frm 00053 Fmt 6633 Sfmt 6633 K:\DOCS\51588.TXT TERRIE
48 

cause your concerns about the global consequences are right on target. 

Mr. GROOME. We agree. We think it is time to move to a more 

global set of standards on a variety of issues, including hedge 

funds, but not just hedge funds. And second, that is not the answer 

either in and of itself. Due to different legal systems, tax systems, 

and even the desire, quite frankly, for an intelligent, informed supervisor to maintain some discretion, that national authorities 

need to maintain the ability to interpret and have discretion on the 

implementation of those international standards. 

But at some level, I believe, in today’s world and today’s very 

interconnected markets around the world, it is increasingly important to have global standards with, as I said, some degree of national discretion, just recognizing the obvious differences in tax, 

legal, but also I think very healthy for supervisors to understand 

their jurisdictions and employ those rules or standards accordingly. 

Mr. CHANOS. One of the things we noticed about the EC proposals, and I mentioned it in my written testimony, Mr. Chairman, 

is that one of the positive aspects of it is that it does attempt, as 

we called for today, to craft a specific set of regulation and legislation for private investment funds, keeping them distant from mutual funds on the continent or unit trusts, and so on and so forth. 

So that would be along the same lines as we were advocating in 

our written and oral testimony today about—and maybe even amplifying on the going slow versus patchwork and doing it right and 

doing it tailored to the various private investment funds and their 

differences from public investment funds. The E.C. is apparently 

trying to do that. 

Mr. HARRIS. So let me add that I totally agree that you should 

take a slow go approach here and deal with the long-term issues 

rather than a reactionary short term response. 

And with regard to the global integration, there are some good 

ideas that are coming out of the U.K. and places like that, but I 

would much prefer—I mean 70 percent of the investors in the 

hedge fund world are here, they are not there. And 70 percent of 

the worst hedge fund investors, not investment organizations, are 

there and not here. The vast majority of the trouble in hedge fund 

redemptions and so on comes out of Europe, it doesn’t come out of 

the United States. So I would not—I would look at what they are 

doing, take the best of what they are doing, but I would not assume 

a follower position relative to what they are doing over there. 

Chairman KANJORSKI. One last thing. Just prior to the economic 

crisis that occurred in the last year in this country, we were getting 

tremendous pressure from both Wall Street and internationally 

that there was a competition between London and New York, and 

if we did not make some concessions in this country, we were going 

to lose the financial wherewithal of the New York market. Now 

this pressure has gone into a hiatus, probably until we get over the 

international crisis and the national crisis reflected by the recession. 

But when the recession is over and we get to recover, do you 

think that competition is going to rear its ugly head again and we 

are going to be in a race to the bottom for regulation as an attracVerDate Nov 24 2008 17:52 Sep 24, 2009 Jkt 051588 PO 00000 Frm 00054 Fmt 6633 Sfmt 6633 K:\DOCS\51588.TXT TERRIE
49 

tive feature to draw that industry either to London or to New 

York? 

Mr. CHANOS. I live in both cities, Mr. Chairman, and I run offices 

in both cities, and I know Todd represents a group based in London. I like our chances better than theirs right now. I am concerned by more of the things I see going on in London as it relates 

as a financial capital than I am in New York or our cities. 

I still think there is a strong sense of free enterprise here that 

I am seeing erode very quickly in London, personally, and a move 

toward immediate higher taxation over there. And they are actually beginning to worry about losing their ascendancy to places like 

Geneva or Dubai or other places, so it is all relative. The grass is 

always greener. But as someone who lives and almost commutes 

between the two cities, I like our chances better. 

Mr. GROOME. I would just add that I do not believe it is a race— 

there will always be competition between two cities like that, and 

I think we could arguably see one or two cities in Asia emerge not 

too long in the future who want to compete for that same sort of 

financial center type of mantel. That is all healthy. 

Mr. Chairman, I would say though, that the winner will not be 

the one who races to the bottom of regulation. The winner, in my 

opinion, will be the one who sets very clear rules, very clear standards, and stays with those standards. To the extent that rules and 

regulations and capital structures start to be redefined and renegotiated on the run, people like Mr. Harris will vote with their dollars and yen and euros and renminbis and go somewhere else. 

They will be the arbiters at the end of the day. 

Mr. BAKER. I think there is a significant flight to quality in that 

if there is a particular incident in recent months that has created 

difficulties in the U.K., it has been the apparent difficulty in the 

Lehman resolution, and that many people’s fortunes are to a great 

extent tied to the ultimate resolution, which appears at this moment to be many months away, and that is an unfortunate development. And so at the end of the process, if we get back to normal 

in the next 18 months, I still think the memory of 2008–2009 will 

be quite vivid to most investors and they will demand levels of conduct until we get back into the years when profits run unexpectedly high. 

But these things are cycles. When we came here in the 1980’s, 

we were coming out of the S&L crisis, the tech bubble. I foresee 

at some future point—not near-term—that we will have concerns, 

but I believe the U.S. system offers quality that folks have difficulty finding elsewhere today. 

Chairman KANJORSKI. Mr. Garrett? 

Mr. GARRETT. First of all, I appreciate the closing comments 

most of you assumed in regards to the chairman’s comment as far 

as whether we need patchwork or comprehensive, and comprehensive, thoughtful, and well-thought-out is what I am hearing from 

the panel, so I appreciate that. 

The gentleman from the other side of the aisle knows that inaction is not the answer, but the wrong action directed in the wrong 

place could actually end up doing more harm, I assume the panel 

agrees, than no action at all. I see you all nodding. 

50 

And also my takeaway from this is so many people said registration is not the end, it is only going to be the beginning, because 

with registration, as Mr. Harris pointed out before, we already had 

registration and registration didn’t prevent us from getting to 

where we are right now, even though it is voluntary registration. 

And then along with Mr. Harris’ comment as well, reporting—and 

Mr. Baker’s comment—reporting can do one of two things. If you 

go the next step from registration to reporting, Mr. Groome is saying that you either have everybody reporting, in which case Mr. 

Harris would make the argument that we would be diluting our resources, and we have already heard how the SEC can’t get the job 

done. 

With all due respect to Mr. Chanos’ good comments about the 

SEC, they have not been able to get the job done, and I guess we 

still are going to be bring back the SEC to try to get an explanation 

why, when somebody actually comes to that entity and tells them 

of a problem they can’t get the job done. I don’t know how they are 

going to get the job done if we dilute it to such an extent that we 

are going to have everybody reporting, but I think Mr. Baker 

makes a very good point on the flip side of that. 

If we say that we are only going to pick a segment of that, then 

you get into, potentially, too-big-to-fail, and then you have that situation there and that we may create a whole other host of problems, where will we be bailing out, or, as the suggestion has been 

made, will we be forced to wind them down? Has anybody on the 

panel agreed with the thought that the government should be able 

to step in and wind down any of your clients or any of your hedge 

funds if we see the potential for systemic risk? 

[no response] 

Mr. GARRETT. No? So at the end of the day, I walk away from 

here saying that we need to look at more comprehensive reform. 

And I guess my last question is, are there other areas in the global 

market—and I was going to ask you when are we going to get out 

of this recession and get an expert opinion on that, but I will let 

you submit that in writing— 

But at the end of the day, looking at the global issues that this 

committee looks at—I know Mr. Baker knows them all, but you can 

presume what we look at—we are looking at hedge funds right now 

for the last couple of hours. Where would you, if you were sitting 

up here—Mr. Baker, if you were still sitting up here—what issues 

would you be looking at and saying, ‘‘This should be our number 

one or number two priority?’’ If it is not hedge funds and registration, where would you say our focus should be on trying to get the 

economic house back in order if it is not hedge funds? I will start 

with Mr. Harris and run down. We only have a minute, so— 

Mr. HARRIS. My guess is looking at the investment practices of 

insurance companies. 

Mr. GARRETT. Okay. Mr. Chanos? 

Mr. CHANOS. I would look at the long-term structural liabilities 

that we have overall and how we are fooling ourselves on how we 

are going to fund those, so just broad concept of funding our future 

health and retirement liabilities. That is going to drive everything 

in every financial institution going forward. 

Mr. GARRETT. Our $57 trillion liabilities or what have you, yes. 

51 

Mr. GROOME. I would approach it from the liability side as well, 

and I would think about it from an entity standpoint about our insurance industry or pension fund industry and the increasing 

transfer of risk to the household sector, and trying to actually bring 

it back, in a sense, to a sort of more balanced management of risk 

in our system between private institutions, government, and households, a more balanced system. We seem to swing back and forth. 

In the pension world, for example, we have gone from a DB heavy 

to a DC heavy. I think getting some of that back in balance would 

be very helpful. 

Mr. BAKER. And I also share concerns about the business environment going forward because of the uncertainty of government 

resolution in the current matter. We have had modifications in 

TARP and TALF that make it difficult for business judgments to 

be made with certainty. If we can get past those issues—then I 

hope it is appropriate to suggest that I would survey the top 25 or 

50 CEOs of the companies who are dealing with that exact same 

question and trying to figure out how their survival will be facilitated. And then focus on that liability side, how do we get a business plan together for the next 10 years that has any hope of getting future folks out of debt? 

Ms. WILLIAMS. I would look at the interconnections among institutions in the system, but also I would broaden the discussion 

away from just focusing on institutions and look at other sources 

of risk to the system by looking at products and how certain products are overseen. 

Mr. HARRIS. Could I just add one more? 

Mr. GARRETT. Sure. 

Mr. HARRIS. The financing of our deficits by foreigners could potentially be a huge problem. 

Mr. GARRETT. I appreciate all your comments. Thank you very 

much, gentlemen and ladies. 

Chairman KANJORSKI. Thank you very much, Mr. Garrett. 

Let me say for a second before we go into the formality that this 

panel really has been exceptional, in my estimation. I think we 

have a much better record than I imagined we would come out of 

today’s session with, and it is because we slipped off just the staid 

questions of what is involved. We really went into some of the theory and some of the critical analysis of what we face, so I want to 

thank you for going with us that way. 

This subcommittee has a big role to fill in comprehensive reform, 

and I think we are going to try and do it. I want to compliment 

my ranking member because we are trying to bring civility, and I 

think to this extent we have, to the Congress and the committee, 

and we are going to keep along that line. But we do appreciate the 

collective members of this panel and each of you. 

And I would invite you to do one thing. We are one telephone call 

away, we are one letter away. You all have some great ideas. 

Please feel free to critique us and to inform us along the line, because what we are attempting to lift is very heavy, and I’m not 

sure either Mr. Garrett or I are physically fit to do it on our own. 

We need your help. 

So thank you very much, and with that, the Chair notes that 

some members may have additional questions for the panel which 

52 

they may wish to submit in writing. Without objection, the hearing 

record will remain open for 30 days for members to submit written 

questions to these witnesses and to place their responses in the 

record. 

With no further statements necessary for the record, the panel 

is dismissed, and this hearing is adjourned. 

[Whereupon, at 2:22 p.m., the hearing was adjourned.] 

(53) 

A P P E N D I X 

May 7, 2009 

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