Hedge Fund Fraud and the Public Good

Abstract The current financial crisis resonates with every American, regardless of their connection to the securities markets. Many struggle to understand how and why the American financial and securities markets collapsed last year. In essence, why did the regulators fail to prevent the collapse? Government officials continue to analyze the relationship between the structural collapse of the markets and regulators' limited jurisdiction over a class of entities whose transactions substantially impact the markets: hedge funds. Congress can no longer deny hedge funds' detrimental impact on the financial and securities markets. The impetus for financial re-regulation has arrived. It is incumbent upon Congress to enact laws which extend the jurisdiction of federal regulators to hedge funds. At a minimum, such supervision is necessary to protect the investing public. The elusiveness of hedge funds and their investment strategies is of particular concern. Federal regulation may take the form of a registration requirement. Perhaps publicly-traded companies should disclose their transactions with hedge funds. More comprehensive regulatory reform options include the creation of a hybrid regulatory hedge fund governance matrix based upon the dollar volume, frequency of trades and potential losses that hedge funds may experience. It is incumbent upon Congress to create the proper balance between protecting the investing public and maintaining sustainable American financial and securities markets, which in turn stabilizes the global economy. Today we shall have come through a period of loose thinking, descending morals, an era of selfishness, of individual men and women and of whole nations. Blame not government alone for this. Blame ourselves in equal share. . .. - President Franklin Delano Roosevelt1 INTRODUCTION He that is of opinion money will do everything may well be suspected of doing everything for money. - Benjamin Franklin2 The red light on my office phone flashed incessantly, demanding attention. I ignored it. My small, government issued office, courtesy of New York State Attorney General, Eliot Spitzer, would seem to the casual observer the epitome of efficiency; no space was left unused. Each square inch of the office had documents appropriately labeled, categorized, read and re-read. Ah, the duty to read. The fiduciary duty to read, established by the court in Francis v. New Jersey Bank,21 remained with me years after my corporations class. I read and re-read everything. My attention was pulled back to the flashing red light on my phone. I wondered if that strange woman who kept leaving me all those bizarre messages about mutual funds, late trading, capacity, hedge funds and market timing had called again. She had left at least three messages all in rapid fire, exacting phrases like, "you should look into mutual funds and hedge funds late trading stocks. What they are doing is illegal!"4 She left no explanation and certainly not her name. More importantly, she did not indicate how she knew about the alleged fraud. But there was something about her tone that got my attention and piqued my interest. I brought her phone calls to the attention of Roger Waldman, my immediate supervisor.5 I wanted to find out if he knew anything about terms such as capacity, timing, and late trading, which I may have missed during my own corporate transactional days on Wall Street, from his days at Sullivan & Cromwell. He knew nothing. I could tell because he had no reaction when I mentioned mutual funds and late trading. I also shared the curious messages from the strange woman with Bureau Chief, Eric Dinallo.6 I received permission to offer her transactional immunity and to have her come to the New York State Attorney General's Office to be queen for the day and share her story. All I had to do was find her, convince her to testify, and turn state's witness - because it was her civic duty. …