Spitzer swoops to clip hedge funds

IT'S a bad time to be a hedge fund operator. The long arm of the law - in the form of New York Attorney General Eliot Spitzer - is encircling the $600bn (£370bn) business for a closer look.

The industry's most visible frontman, Kenneth Lipper, is beset by losses and a lawsuit accusing him of misdeeds in managing money for an A-list group of Hollywood, Washington and Wall Street celebrities. A spokesman for Lipper said the suit had no merit.

Another high-profile hedge fund, Gotham Partners Management, started by two Harvard Business School graduates, is being investigated by regulators and hit by a wave of redemptions.

It is selling its biggest stake, in a Canadian car parks operator, so it can repay rich investors who want to get out. Gotham's young founders started the company in 1993 with $3m. By 2000, their assets had mushroomed to $568m. It has been downhill since.

To top it off, last year hedge funds suffered the first down year in 16, evidence the ability to go long and short and leverage positions - as hedge funds do - doesn't guarantee profits in turbulent times.

Last year, the average US hedge fund lost 3.43%, according to Hennessee Group. That is better than the double-digit losses suffered by the average equity mutual fund, but it is not good for an industry that prides itself on making money in lean times and typically charges high fees. More than 10% of the 6,000 hedge funds shut down last year, according to one estimate.

A-list of clients

HEDGE king Ken Lipper, an Oscar winner who wined and dined with actors, politicians and Wall Street power brokers, is in the process of liquidating Lipper Convertibles LP, an arbitrage hedge fund that catered to the rich and famous until it lost 44% of its value, or about $330m, in 2001. Lipper is in court distributing what is left of the shrunken assets, under investigation by the Securities and Exchange Commission (SEC) and fending off lawsuits.

His A-list clients reportedly included actors Julia Roberts and Liam Neeson, former Federal Reserve Board chairman Paul Volcker and Disney chairman Michael Eisner, among others.

One dissatisfied investor, the executive overseeing the trust of senior Senator Ernest 'Fritz' Hollings, has accused Lipper of mishandling the fund at investors' expense. Lipper was an adviser to Oliver Stone's 1987 critically acclaimed film Wall Street, and the Hollings Trust suit alleges that Lipper's morals were not much better than those of the film's greedy tycoon, Gordon Gekko.

The suit alleges Lipper and several close friends and family withdrew large amounts shortly before the money manager announced the fund was in trouble. Lipper won his Oscar for a documentary on the Holocaust he produced with Steven Spielberg, but today he is trying to avoid the spotlight. He didn't appear at a recent Supreme Court hearing in Manhattan concerning distribution of his fund's assets.

Because he ran in fast Hollywood and Manhattan circles, Lipper's fall from grace has attracted public attention to the arcane world of hedge funds. The regulators, however, were already paying close attention.

Spitzer, alongside the SEC, is looking into activities at Gotham Partners and several other hedge fund companies to see if the firms attempted to influence share prices by issuing tainted research. The hedge-funds probe comes only weeks after the New York Attorney General's office settled a high-profile investigation on Wall Street over allegations the major firms issued flawed research reports to hype the companies they covered.

Now Spitzer wants to know if some hedge funds have engaged in yet another form of manipulative research. According to several companies, including bond insurer MBIA and Federal Agricultural Mortgage Corporation (called FarmerMac), some hedge companies issued negative reports intended to push their stock down.

No strict controls

HEDGE funds are typically secretive and don't disclose their holdings or their internal research on companies in which they have taken positions. But three of them allegedly published reports on the internet about companies in order to influence their share price.

Hedge funds are not subject to the same strict disclosure requirements as mutual funds. In the past, regulators have typically shied away from strict controls because hedge funds cater to a small, select and usually sophisticated group of wealthy investors. Most hedge funds have fewer than 100 investors. But the damage they inflict can be huge. Hedge funds typically leverage their positions. Mutual funds can only lose the amount investors put in, while hedge funds can lose much more.

In 1998 Long Term Capital Management threatened to destabilise the global financial system because it had more than a billion-dollar position in money markets moving the wrong way, and only limited assets to back it up. The New York Federal Reserve helped arrange a rescue of the hedge fund.

The latest debacles come at a time when the SEC is taking another look at updating regulations. The betting is that the SEC's enforcement staff will decide better disclosure and more oversight is needed to protect the industry from itself.