Paulson to hedge funds: "Make it work."

A major feature in the Washington Post on the recent decisions and legacy of Treasury Secretary Henry Paulson notes that he believes that it is time to begin regulating hedge funds, reversing his long-held opposition. "You should not be thinking about how to fight it [regulation] but how to make it work," Paulson is quoted telling hedge fund managers.

Paulson is reported to have said that the policy statement he crafted on hedge funds in January 2007, which stated they should not be regulated, was wrong.

The article says that Paulson is working on a proposal that would grant the federal government broad new powers to take over a wide range of financial firms (beyond banks) whose collapse could endanger the financial system. Paulson said Congress would have to define which companies meet the criteria and determine how much they would contribute to a fund that would help cover the cost of closing them in an orderly fashion if they cannot be saved.

Regulation is coming. Hedge funds need to act proactively to make sure the regulation is sensible. Part of the process is demonstrating to Congress, the media and the public the important roles they play in enforcing good governance, providing liquidity in markets, and the degree to which they are an important source of capital to an economy constrained by banks' inability to lend.

Governance priorities for the new administration

The banking crisis and the state of the U.S. auto industry have investors looking more closely than ever at corporate management teams and the accountability of boards of directors. Hedge funds should act opportunistically now to advocate in the media, the board room, Capitol Hill and on Main Street for improvements to corporate governance.

For starters, Nell Minow, co-founder of The Corporate Library has posted her governance to-do list at Carl Icahn's blog. Her priorities range from executive pay to board elections to regulatory reforms.

Also relatively new at The Icahn Report is Mr. Icahn's United Shareholders of America intiative which promises to "push back against board entrenchment and make it easier for shareholders to promote change in companies they own." People can "join" the campaign and receive email updates about its work.

Carl Icahn discussed corporate governance in an extended interview with the Wall Street Journal last Saturday.

Reputational risk prominent in Pershing Square investor letter

In his third quarter letter to investors in Pershing Square Capital Management, William Ackman inlcudes seven paragpahs on "reputational and regulatory risks." Citing reputation risk as a "key risk factor" in the industry, he writes about the steps the fund is taking to preserve its reputation in this volatile environment. "Our approach to assessing reputational risk is to apply the New York Times test. We ask ourselves whether we would be comfortable having our family and friends read a front page New York Times story about actions taken by Pershing Square written by a knowledgeable and intelligent reporter who has access to all of the facts. If we are comfortable with such an article being read by our close friends, our families, and the public at large, our action passes the test. If not, we reconsider our potential action."

He also writes that he has recently decided to take public positions about issues affecting the hedge fund industry (see previous posting on this blog). He writes that it is "important for the hedge fund industry to come out of the shadows and defend the importance of our work." He continues, " If we and others (that includes hedge fund investors in addition to the managers) don’t do so, the industry, in my view, is at even greater risk of further regulatory, tax, and other legal changes that will materially harm our business models and industry."

Ackman cites the short-selling ban as one example of misplaced regulation that the industry was powerless to stop.

Mr. Ackman, if more hedge fund managers follow your lead on reputation management, this blog will be out of business. Until then, we salute you.

William Ackman interviewed by Charlie Rose

On Tuesday, William Ackman, CEO of Pershing Square Capital was interviewed on PBS' Charlie Rose program. You can view the video here. In the half-hour segment Mr. Ackman gives thoughtful analysis of the financial crisis, prescribes solutions for Freddie, Fannie and GM, and talks about the need for regulation of credit derivative swaps. When asked about the hedge fund hearings that ocurred on Capitol Hill today, he says that Congress is "looking for a scapegoat." He also says that the through the bans on short-selling the SEC has "destroyed opportunistic capital" and contributed to the crisis of confidence in the markets.

Mssrs. Ackman, Einhorn, Paulson, Griffin and other leaders in the industry need to be in front of the issues and the camera more frequently. Only then will they have the chance to head off unwarranted regulation of the hedge fund industry and influence government priorities and action in this and future financial crises.

Hedge fund leaders endure Waxman hearing

Hedge fund directors George Soros, chairman of Soros Fund Management LLC, James Simons, director of Renaissance Technologies LLC, John Alfred Paulson, president of Paulson & Co Inc, Philip Falcone, senior managing director of Harbinger Capital Partners, and Kenneth Griffin, CEO and managing director of the Citadel Investment Group testified before the US House Oversight and Government Reform Committee today.

The fund managers supported the creation of a clearning house for credit derivative swaps and cautiously open toincreasing disclosure requirements for hedge funds. Most criticised the federal response to the financial crisis. Short-selling was defended, as was treating gains from investments in hedge funds as capital gains, not ordinary income.

Read the summary of the hearing at the Wall Street Journal and its great "live blogging" from the hearing room.

The first hearing of the day, which featured testimony by academics and former financial regulators, can be viewed via C-Span here.

Activist campaigns gaining support

A panel at The Deal's M&A Outlook 2009 conference discussed the effectiveness of hedge funds' activist campaigns. The panel noted that "activism" applies to any shareholder that tries to improve the performance of a company. Hedge funds were noted for their ability to get companies to better communicate with investors about their strategy and performance. It was pointed out that activists are getting more "aggressive and creative" and that institutional investors who are not themselves activists do align with activists to instigate change.

When advocating change at an underperforming company, the investor has the high ground. A sensible business case or complaint about poor corporate governance instantly arms the investor with tools needed to a) pressure the company through direct discussions, the media and other means; and b) gain the support of other investors who would also benefit from the desired change.

Hedge funds are virtually the only institutions in our market with the sophistication and wherewithal to effectively advocate for change at corporations. The role of sheriff is important and hedge funds should embrace activism as a regular business strategy, not only to identify and create value, but also to enforce market discipline and fair play.

Traxis downplays risks of redemptions

Barton Biggs, director at Traxis Partners says at Fortune.com that fears about the market and possible effects of redemptions from hedge funds are overblown. He estimates that about $250 billion worldwide will be withdrawn from hedge funds by mid-2009. He notes that this is a relatively small amount and that funds have been preparing for it (the industry's net long position is said to be about 20% of equity, an all-time low).

He points out that despite well-publicized losses by the hedge fund industry this year, traditional long-only managers have done worse. This should mitigate redemptions. "So where are the redeemers going to put their money?" asks Biggs.

The industry needs more voices like Biggs advocating the, ahem, long view.

Hedge titans to testify on Capitol Hill

Leaders of the hedge fund industry, including Philip Falcone, Kenneth Griffin, John Paulson, James Simons and George Soros are scheduled to appear before the House Committee on Oversight and Government Reform on Thursday. A preview story in the Wall Street Journal notes that the Managed Funds Association and other organizations representing hedge funds are spending record amounts lobbying, according to industry insiders. The story says that having five of the best-known and wealthiest investment managers together publicly before Congress is "unprecedented." It's not going to be pretty and one can almost hear the pontification of Waxman and others now.

This blog has long argued that the hedge fund industry has done a poor job of safeguarding its reputation and defending its practices, like shorting, to the Hill, the media and others. All this lobbying by MFA sounds like too little way too late.

Waxman, it should be noted, is a grand inquisitor of all kinds of perceived high-crimes and misdemeanors. After all, he called Roger Clemens to testify about his use of steroids in Major League Baseball.

Read the Financial Times' preview here.

Jack Welsh on how to "survive a media mauling"

Jack Welsh's latest column in BusinessWeek focuses on how to manage through media crises. His advice isn't rocket science: tell the truth, tell one version of the truth, etc. He does, however, point out the need to take "media coverage into your own hands" via the Web. Welsh accurately notes that the Web is a critical defensive and offensive tool in combatting negative publicity.

The media are not the bad guys, and in Welsh's own words, "the only question is whether you have the guts to engage the media as they engage you."