How to say we're sorry

Financial Times columnist Lucy Kellway deconstructs investor letters from hedge funds. In her sights are the recent investor letters issued by Greenlight Capital and TPG-Axon. The story brings into harsh relief a very important question: what do you say to investors when you are down 20, 30 or 40%? Using these two funds as templates, Kellway notes 8 "rules" of the investor letter, ranging from being too long to sounding upbeat about the future.

What she doesn't appreciate or mention in the article is that, in these circumstances, the letter is a formality. The more important communications with investors are happening in person and over the phone.

Click here for the Greenlight letter.

Click here for the TPG-Axon letter.

Greenwich Financial Services sues Countrywide and opens Pandora's Box of media scrutiny

Greenwich Financial Services has raised the hackles of Lou Dobbs and Congresswoman Maxine Waters, among others, over its decision to sue Countrywide after the bank decided to modify the terms of 400,000 troubled mortgages. Greenwich says that modifying the loans damages the financial interests of the bondholders.

William Frey who heads GFS and his attorney both appeared on a CNN interview. They deserve a lot of credit for taking a very unpopular position in a very public manner. Hopefully, their investors will appreciate the effort.

The explosiveness of the situation and risk undertaken by GFS is clear in the CNN interview when Rep. Maxine Waters refers to GFS as "greedy hedge fund operatives...looking for fast money."




The New York Times writes about the lawsuit and includes more details about the complaint.

Check out the Deal Professor's analysis of Countrywide's pooling and servicing agreements and the merits of Greenwich's claim.

Survey: 98% of hedge fund managers expect new regulation of industry

A survey by accounting firm Rothstein Kass finds that virtually all hedge fund managers expect increased regulation. Areas where new regulation is expected include: asset valuation, counterparty risk management, capital raising and transparency. 77 percent of the respondents said that the overall impact of the new administration on the hedge fund industry "will not be positive."

Hedge fund cowboys "fell off their horses"

The infighting has begun. In a story on Reuters, Veritas Asset Management manager Ezra Sun blames his fellow fund managers for the "tremendous" reputational damage he sees the industry having sustained. Sun accuses hedge fund "cowboys" of not properly hedging, boosting returns through unwise borrowing, charging high fees, and locking up investors once the losses started piling up.

While accurate, Sun's critique further damages the industry. Rather than finger pointing at the very visible bad apples, we should reading about seasoned managers who are weathering the storm and earning their keep for preserving, if not enhancing, their clients' assets. Investors need to hear that the good managers are surviving and that the industry will emerge from the current crisis stronger and smarter.

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."

Citadel holds conference call to calm bondholders

Last Friday, hedge fund giant Citadel held a conference call with bondholders to quench rumors about its losses, standing with counterparties and need to liquidate holdings. More than 1000 people tried to dial into the call. Breaking Views outlines the substance of the call while noting that it is very difficult for a financial institution to deal with rumors. At a time when former Lehman executives are under investigation for misleading investors, the market simply does not know how to interpret what banks and others are saying. As a result, it is a Catch-22 to say anything at all. The New York Times offers a play-by-play of the call.

Self-inflicted wounds hurt hedge fund industry

Dealbook by the New York Times reports that Andrew Lahde is closing his funds and returning money to investors. The article reprints Lahde's "farewell" letter to investors. Unfortunately, the letter is more of a "screw you" than a farewell and wanders into head-scratching territory including a defense of growing hemp and recommendations on what George Soros should do with his free time.

Lahde writes, "I was in this game for the money. The low hanging fruit, i.e. idiots whose parents paid for prep school, Yale, and then the Harvard MBA, was there for the taking. These people who were (often) truly not worthy ofthe education they received (or supposedly received) rose to the top of companies such as AIG, Bear Stearns and Lehman Brothers and all levels of our government. All of this behavior supporting the Aristocracy, only ended up making it easier for me to find people stupid enough to take the other side of my trades. God bless America."

That's all the industry needs: proof that egotistical managers are pulling fast ones on naive investors.

Hopefully, people (and the media) will recognize that Lahde operated his own LA-based fund for less than two years and his opinion should be taken with a grain of salt.

A story on Bloomberg gives a little more information about Andrew Lahde.

Paulson comment foreshadows storm for hedge fund industry

According to an email sent to a colleague, former Lehman Brothers CEO Richard Fuld said Treasury Secretary Henry Paulson wants to "kill the bad HFnds + heavily regulate the rest." Fuld was in a very public battle with short sellers, but this sentiment held by Paulson (if accurate) should send shivers down the spine of the hedge fund industry.

With the ban on short selling, it is clear that Treasury and other regulators have view collateral limits on trading options of hedge funds simply as collateral damage the battle against the financial crisis.

More regulation seems inevitable and, the industry is not well-positioned to do much about it. For too long hedge funds have tried to fly under the radar, but it was naive to think that a $2 trillion industry would not attract outside scrutiny or regulatory interference. The industry resisted even the slightest infringement on independence, like registration. It turned a blind eye to high-profile cases of fraud and deception. It did not view challenges involving risk management, valuation, market practices and governance as risks to the entire industry.

Most important, the largest, most institutionalized funds did not band together (as was done in Europe) to create a unified front against unnecessary regulation and to serve as the voice of the industry in an increasingly shrill political and media environment.

It is ironic that Henry Paulson would want to kill the bad hedge funds and heavily regulate the rest. Isn't Goldman Sachs, after all, a giant hedge fund? However, the statement shows just how vulnerable the hedge fund industry is.

Reputation, regulation and hedge funds' consternation

The UK-based Hedge Funds Standards Board recently announced that its increased membership now represents half of the hedge funds assets in Europe. HFSB chairman Antonio Borges said in an interview with Reuters that he fears regulators could be swayed into enacting harful legislation in the wake of the credit crisis. "The reputation of the industry will drive public opinion and therefore politicians in directions which might be harmful for all of us, not just hedge funds," he said.

Hedge funds in the U.S. can almost certainly count on new regulations. Even Republican nominees McCain and Palin are calling for more oversight of financial markets. If the industry could not effectively head off the ban on short selling (Borges calls such a ban "bad for the whole market"), how can it hope to avoid more and even more onerous restrictions, now that the crisis has deepened?

Who is spooking whom?

Tina Brown's new news Web site The Daily Beast asks the question: is the media spooking the market? The article offers examples ranging from Jim Cramer to the outdated story on United Airlines that each are correlated "panic" among investors. Is the media to blame? I don't think so.

Rather, the media and investors are themselves spooked by bank CEOs, the President, Bernake and Paulson, none of whom effectively have explained the roots, extent and, most important, remedy for the financial crisis. In this vacuum bad news sounds worse than it is and pessimism is unchecked. But don't blame the media.

It is this same lack of leadership and demonstrable solutions that leads to ineffective half-measures like the ban on short selling. It is questionable whether the ban fulfilled its intention, given the freefall we've seen in the markets this week. However, the real solutions were not forthcoming and regulators had plenty of political cover for sticking it to the hedge fund industry. (The industry's anemic efforts to head off the short selling ban is best discussed in a separate entry.)

For the record, as early as 2005, reporters at The Wall Street Journal were asking my clients about the state of the mortgage market, risks of subprime lending, and risk management practices in mortgage lending. The media was right, it was everyone else who had their heads in the sand.

CEOs, lies and tickertape

A colunn by Andrew Ross Sorkin in the New York Times examines whether financial CEOs can tell the truth about the state of their companies. He notes that Wachovia CEO Robert Steel told CNBC just two weeks ago that the bank had "a great future as an independent company." Wachovia's banking business was sold to Citigroup on Monday. Was Steel lying? Was Lehman CEO Richard Fuld lying about the prospects of that, now defunct, bank? Maybe yes, maybe no.

Clearly, financial CEOs are trying to reassure investors, who these days don't need much to head for the door. Being negative, realistic or telling the "truth" could result in the proverbial run on the bank. Truthfully.

At the same time, maybe, just maybe conditions facing banks are moving so quickly that CEOs truly don't know what the future of their institutions holds. The Wall Street Journal reports that Wachovia executives and directors bought $30 million of Wachovia stock this year. They, surely, didn't foresee selling the bank for $1 per share. Steel himself bought $16 million of stock when he was appointed CEO. Similarly, insiders at AIG and WaMu also bought shares in their companies and, presumably, lost big.

See a related Hedge Lines entry on this topic.

Atticus gags self

Atticus Capital, which has been denying rumors about its solvency, recently announced that it would suspend issuing mid-month reports because investors had been "leaking" them to the press. The fund will continue to issue end-of-month reports.

The decision comes at a time when hedge funds are closing, even big ones like Ospraie and speculation about future closings are generating the wrong kinds of headlines for the industry.

It raises interesting questions about how to report and communicate with investors and what can reasonably be expected to kept private in an increasingly transparent world.

Hedge funds should assume that whatever they publish could make its way into the public domain. But if a fund is down 25%, like Atticus is, the least of its problems is what may or may not appear in The Wall Street Journal.