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The Hedge Fund and Alternative Investment Bleeding Edge Blog

Who will betray us next?

September 24th, 2007

Despite all of our testosterone fuelled claims of market dominance, despite our purported independence of judgment, investors depend on others for information, analysis and advice.  In many ways, therefore, one of the most important questions an investor can ask is, “Who can I trust?” 

The Enron disaster was, in part, a betrayal by management.  Andrew Fastow, the convicted, former CFO of Enron set up front corporations and paid himself consulting and management fees with Enron funds as if he was an outsider and not the most inside of insiders.  Unfortunately, not all of the blame can be laid on Fastow, Lay, Skilling and the rest of Enron’s management scum.  Investors were also betrayed by Enron’s accountants and, much, much, worse Enron’s auditors, Arthur Anderson and Company.  Auditors are supposed to protect investors.  They are supposed to insure that management tells the truth.  Enron’s auditors lead us astray because they were managed by Enron, not by Enron’s investors or, at least, their representatives and because they had been paid off. 

The current meltdown in the sub-prime mortgage market is, in part a betrayal by mortgage lenders.  For several years, anyone with a pulse could get a mortgage and even those without a pulse were not completely without hope.  Much worse, investors were also betrayed by the bond rating agencies, who gave this sludge higher ratings than it deserved.  Again, these are people we should have been able to trust.  Again, management bought them off.


The question I would like you to help me answer is this: Who do you think will betray us next?  Whose greed and irresponsibility has reached new limits?  I am interested in groups, not individuals.  I am interested in “auditing firms” not “Arthur Anderson.”  And I am only interested in groups we are supposed to be able to trust. 

Lock Down Your Money Manager: A Technique for Getting Them on Your Side.

September 13th, 2007

A few weeks ago, Brett Arends, mutual fund columnist at The Street, reported that Alan Greenberg, Sam Molinaro, James Cayne and Warren Spector had dumped Bear Stearns’s stock when it was selling at $172.  On the day before Mr. Arend’s article was published, the stock closed at $117.78.  A gift of prophecy, perhaps?  Dumb luck?  Inside information?  All four were Bear Stearns’s executives.  According to Mr. Arends, Bear Stearns declined to comment.


As far as I know, these people did nothing illegal.  The law, correctly, presumes innocence.  In my opinion, however, an investor or fund of funds manager should never be so generous.  In my opinion, an investor should always presume that the nice man on the other side of the desk would sell the investor’s children into sexual slavery if he thought he could get a dollar and a quarter on them.  I know some people who would make the sale for a lot less.  That’s not a joke.  Not all of the people I know are honest citizens.


Calpers code of ethics currently requires investment managers to own shares of their own funds.  As always, Calpers is on the cutting edge.  But Calpers is not going anywhere near far enough.  In my opinion, investment managers should be contractually required to invest a substantial portion of their own money in their own funds and they should be contractually prohibited from removing their money without giving substantial notice.

To be perfectly honest, I’m not completely sure what ‘substantial notice’ means.  What I am sure of is that the notice should depend on the liquidity and transparency of the fund’s investments.  The CFA code of ethics requires that an investment manager’s client’s trades execute before the investment managers.  We need something similar here.  Plus time for the client to think the issues through.  If a client is required to give three months notice, the investment manager should be required to give six months.  And even that may not be enough.  If the investments are illiquid or opaque, if side pocket arrangements are necessary, the lockdown may need to be even more restrictive.  If this kind of arrangement has a name, I haven’t heard it.  I propose calling it an investment manager lockdown.


To be fair, I have to mention that this will add a burden to the investment manager’s load.  Hedge funds and other alternative investments are specialty investments; they should normally be a modest part of a diversified investment portfolio.  An investment manager who submits to a lockdown will, therefore, end up owning an under diversified portfolio.  Worse, perhaps, that manager might not be able to liquidate his portfolio during an emergency, his home burning down, for example.  Perhaps this is a character flaw on my part, but I have no sympathy for investment managers here.  If investment managers are really as financially sophisticated as they claim, these issues should not be a problem.