[House Hearing, 111 Congress]
[From the U.S. Government Publishing Office]



 
                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


                  U.S. GOVERNMENT PRINTING OFFICE
51-588                    WASHINGTON : 2009
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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                 BARNEY FRANK, Massachusetts, Chairman

PAUL E. KANJORSKI, Pennsylvania      SPENCER BACHUS, Alabama
MAXINE WATERS, California            MICHAEL N. CASTLE, Delaware
CAROLYN B. MALONEY, New York         PETER T. KING, New York
LUIS V. GUTIERREZ, Illinois          EDWARD R. ROYCE, California
NYDIA M. VELAZQUEZ, New York         FRANK D. LUCAS, Oklahoma
MELVIN L. WATT, North Carolina       RON PAUL, Texas
GARY L. ACKERMAN, New York           DONALD A. MANZULLO, Illinois
BRAD SHERMAN, California             WALTER B. JONES, Jr., North 
GREGORY W. MEEKS, New York               Carolina
DENNIS MOORE, Kansas                 JUDY BIGGERT, Illinois
MICHAEL E. CAPUANO, Massachusetts    GARY G. MILLER, California
RUBEN HINOJOSA, Texas                SHELLEY MOORE CAPITO, West 
WM. LACY CLAY, Missouri                  Virginia
CAROLYN McCARTHY, New York           JEB HENSARLING, Texas
JOE BACA, California                 SCOTT GARRETT, New Jersey
STEPHEN F. LYNCH, Massachusetts      J. GRESHAM BARRETT, South Carolina
BRAD MILLER, North Carolina          JIM GERLACH, Pennsylvania
DAVID SCOTT, Georgia                 RANDY NEUGEBAUER, Texas
AL GREEN, Texas                      TOM PRICE, Georgia
EMANUEL CLEAVER, Missouri            PATRICK T. McHENRY, North Carolina
MELISSA L. BEAN, Illinois            JOHN CAMPBELL, California
GWEN MOORE, Wisconsin                ADAM PUTNAM, Florida
PAUL W. HODES, New Hampshire         MICHELE BACHMANN, Minnesota
KEITH ELLISON, Minnesota             KENNY MARCHANT, Texas
RON KLEIN, Florida                   THADDEUS G. McCOTTER, Michigan
CHARLES A. WILSON, Ohio              KEVIN McCARTHY, California
ED PERLMUTTER, Colorado              BILL POSEY, Florida
JOE DONNELLY, Indiana                LYNN JENKINS, Kansas
BILL FOSTER, Illinois                CHRISTOPHER LEE, New York
ANDRE CARSON, Indiana                ERIK PAULSEN, Minnesota
JACKIE SPEIER, California            LEONARD LANCE, New Jersey
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

        Jeanne M. Roslanowick, Staff Director and Chief Counsel
 Subcommittee on Capital Markets, Insurance, and Government Sponsored 
                              Enterprises

               PAUL E. KANJORSKI, Pennsylvania, Chairman

GARY L. ACKERMAN, New York           SCOTT GARRETT, New Jersey
BRAD SHERMAN, California             TOM PRICE, Georgia
MICHAEL E. CAPUANO, Massachusetts    MICHAEL N. CASTLE, Delaware
RUBEN HINOJOSA, Texas                PETER T. KING, New York
CAROLYN McCARTHY, New York           FRANK D. LUCAS, Oklahoma
JOE BACA, California                 DONALD A. MANZULLO, Illinois
STEPHEN F. LYNCH, Massachusetts      EDWARD R. ROYCE, California
BRAD MILLER, North Carolina          JUDY BIGGERT, Illinois
DAVID SCOTT, Georgia                 SHELLEY MOORE CAPITO, West 
NYDIA M. VELAZQUEZ, New York             Virginia
CAROLYN B. MALONEY, New York         JEB HENSARLING, Texas
MELISSA L. BEAN, Illinois            ADAM PUTNAM, Florida
GWEN MOORE, Wisconsin                J. GRESHAM BARRETT, South Carolina
PAUL W. HODES, New Hampshire         JIM GERLACH, Pennsylvania
RON KLEIN, Florida                   JOHN CAMPBELL, California
ED PERLMUTTER, Colorado              MICHELE BACHMANN, Minnesota
JOE DONNELLY, Indiana                THADDEUS G. McCOTTER, Michigan
ANDRE CARSON, Indiana                RANDY NEUGEBAUER, Texas
JACKIE SPEIER, California            KEVIN McCARTHY, California
TRAVIS CHILDERS, Mississippi         BILL POSEY, Florida
CHARLES A. WILSON, Ohio              LYNN JENKINS, Kansas
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

                            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


                         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 patchwork 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 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?
    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 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 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.
    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 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. Without 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.
    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 fund-related 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 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 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 particular 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 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 Investment 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.
    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 
totally 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.
    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.
    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.
    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 disclosure 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 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 non-bank 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 non-banks, 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?
    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 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?
    [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 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 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.
    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 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 insurance 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 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.
    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.
    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 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 enforcement 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 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.
    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 
wondering 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.
    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 three-quarters 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.
    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 
exception 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.
    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 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 information 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 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 Financial 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 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 long-term 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, because 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 attractive 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.
    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.
    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 
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.]


                            A P P E N D I X



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