Talk:Hedge fund/Archive 4

Systemic risk
I have a couple of suggestions for the third paragraph of Debates and controversies'#Systemic risk, aiming to improve the accuracy a bit. The paragraph currently reads, with the problem areas highlighted:

"Nevertheless, although hedge funds go to great lengths to reduce the ratio of risk to reward, inevitably a number of risks remain.[181] Systemic risk is increased in a crisis if there is "herd" behaviour, . The extensive use of leverage (loans to amplify gains) can lead to forced liquidations in a crisis, which can be exacerbated by the illiquid nature of some investments. The close interconnectedness of the hedge funds with their prime brokers, typically investment banks, can lead to domino effects in a crisis, and indeed failing counterparty banks can freeze hedge funds."

However, as all investors in the herd would lose funds in such a situation, I'd like to tweak the wording a bit to clarify this. Also, the last sentence is simply a restatement of risks already cited in greater detail above. I would suggest cutting to make the section more concise. My proposed revisions are below:

Thoughts from others? Cheers, WWB Too (Talk · COI) 16:12, 14 May 2013 (UTC)


 * I only partly agree with that, personally. In particular, in relation to the last bit, I think a distinct point is being made, albeit not with maximum clarity. Here is my attempt at addressing the points you make:


 * The changed bits are highlighted. Wildfowl (talk) 22:03, 14 May 2013 (UTC)
 * Thanks for your patience, Wildfowl. Your edits to the first highlighted bit are OK with me, so if you want to make that change, I'm all in favor. On the second bit, I'm doing a bit more research, and I'll aim to have a more detailed reply here soon. No need to check back, I'll ping you when I'm ready. Cheers, WWB Too (Talk &middot; COI) 15:59, 17 May 2013 (UTC)

Hi Wildfowl, after some research, I've updated my proposed revision once again, below. You'll see I have kept the "large sums of money" sentence intact, adding only the qualifier "can". I then include a few sentences summarizing a recent analysis of the hedge fund leverage before-and-during the 2008 financial crisis by the National Bureau of Economic Research, which states that hedge fund leverage is fairly modest compared to investment bank leverage, and decreased prior to the financial crisis. (It's behind a $5 paywall, so I've quoted from relevant sections.) These findings also reinforce observations attributed to Sebastian Mallaby in the second paragraph.

It's longer to be sure, but if the current last sentence stays, I think this provides useful context. What do you think? WWB Too (Talk · COI) 21:39, 20 May 2013 (UTC)


 * Your clients (Managed Funds Association?) seem to be touchy about charges of increasing systemic risk! I have a feeling that we aren't going to be able to agree on this one. You have obviously put some work into that new wording, but it doesn't seem to me to add much that is relevant to the rest of the paragraph. There are words on leverage in the second paragraph of the systemic risk section, so a risk of overlap. My suggestion would be that we stick with my version. Either that or add a separate paragraph that deals with the pros and cons of leverage as regards risk, since you have done the work. (Anybody else can join in this discussion.) Wildfowl (talk) 19:29, 21 May 2013 (UTC)


 * That's right, MFA. Of course I wouldn't say "touchy" but rather "concerned about proper context and accuracy"—and I think they're right: the current sentence makes a rather vague assertion of there being risks because of the sums involved, although the context of "systemic risk" and first paragraph make this apparent, while the second paragraph establishes the fact that hedge funds fail on the regular, without imperiling the system. There is also not a citation given for this sentence, which should be of some concern given it's such a sweeping statement. So I'm in favor either of striking it, or providing more context. If you think we can't find a compromise on this, perhaps it's time to go seek a third opinion? Cheers, WWB Too (Talk &middot; COI) 17:15, 23 May 2013 (UTC)


 * The paper's conclusions might be worth including although I'm not sure if what's proposed is the best summary. Per pdf page 27, the countercyclical conclusion relies on Figure 7 (pdf page 57). The section is short and not very detailed and relies only on leverage ratios - it doesn't discuss buying/selling really at all, and liquidating into a crash is an important component of systemic risk (my intuition is that covering shorts may have a countercyclical effect but this is not mentioned at all). So this really seems like a very simple analysis. As far as leverage, generalizing is tricky since per the NBER paper the gross leverage average is around 2.1 but is as high as the 30s for some firms and around 4.8 for relative value compared to 1.6 for long-short equity and 1.3 for event based. I also think the prose could be tightened to summarize a little more concisely. The interconnectedness needs a comment on empirical research if any is available. I don't like using 3 footnotes for a single reference and quotes are not required and are more distracting than useful (I use for page numbers).  II  | (t - c) 18:13, 23 May 2013 (UTC)


 * Hi, thanks for weighing in, Imperfectly. Can I ask what you'd suggest for an alternative summary? I think it would be helpful for us to see what another take on that may be. No particular rush. Cheers, WWB Too (Talk &middot; COI) 13:31, 24 May 2013 (UTC)
 * Are you aware of any recent articles which discuss systemic risk in hedge funds from another perspective? I haven't had a chance to do much of a lit review. II  | (t - c) 18:49, 26 May 2013 (UTC)
 * Been looking into this. Emergence of a New Regulation: Informational Disclosure Modalities in the Hedge Fund Opacity (2012) has a somewhat different take, with its arguments including:
 * "...They turn their portfolio over far more frequently than traditional funds, so their short-term influence on markets can be greater than the actual capital under management would indicate..."
 * "...When markets are stable,  the presence of hedge funds can boost liquidity, but  under stressed conditions hedge funds would be probably the first to exit because they cannot afford to wait when leveraged positions begin to lose money..."
 * "... Moreover, competition  encourages  hedge funds to have the same strategies; that is to say that a group of hedge funds is exposed to the same  risk  factors.  A  research  study  by  ECB  confirms:  “[…]  correlations  between  hedge  fund strategies have been continually increasing since mid-2003 with a peak in 2005” (Garbaravicius, Dierick,  2005)..."
 * I'm still not sure exactly how to revise the section but I'll be trying to work on it over the next couple weeks. II  | (t - c) 23:56, 26 May 2013 (UTC)


 * Apologies for the delay, Imperfectly. As a matter of fact, there's a UK Financial Services Authority report from August 2012 you might find worthwhile. It is called: Assessing the possible sources of systemic risk from hedge funds. Let me know if you have any questions. Cheers, WWB Too (Talk &middot; COI) 13:57, 30 May 2013 (UTC)

That's interesting, altho the fact that it relies upon voluntary data seems like a major flaw which makes me reluctant to cite it. I've forgotten whether Ang et al is based on voluntary data, and it appears that now NBER is charging for access. There's actually an enormous literature on hedge funds so I'm reluctant to dive in with edits. I was not able to confirm the "Emergence of New Regulation" paper's quote on herd behavior from the ECB study - it doesn't seem to appear in the ECB's paper "Hedge funds and their financial implications". So I won't use that. Incidentally (and for my future reference), the ECB paper has some good hard data on prime brokers in Table 13 and 14 (pages 39-40 of the pdf). Following the line of evidence on herding, I found Hedge Fund Herds and Crowds: The Apologists’ Evidence (2012), but it doesn't seem to have been published yet. The ECB paper has some information on leverage which I'll look into. The benefit of regulators is that they are sometimes able to extract data non-voluntarily, which is obviously a lot better. II | (t - c) 05:49, 18 June 2013 (UTC)


 * FWIW, WWB Too pinged me on my talk page to ask for another opinion. I have issues with the original sentence but I'm too occupied with other priorities right now to look at the proposed alternatives. If I don't come back here in a week and everyone already involved in this discussion hasn't come to a consensus then please ping me with a reminder on my talk page. Thanks, --Pine✉ 06:21, 25 June 2013 (UTC)


 * Alas, two months in, we still don't have a resolution here, let alone any sustained discussion. The good news is that we seem to have agreement on the first proposed change; the bad news is we lack consensus on the second point. Having already gone to the relevant WikiProjects, and having exhausted our supply of editors recently involved on this page (and I've asked several who have not posted here at all) I think it's time to look beyond—starting with informal channels—and see if we can find our Solomon. WWB Too (Talk &middot; COI) 22:57, 16 July 2013 (UTC)


 * I took a look at this section, and it struck me that the paragraph has a number of problems beyond those raised by WWB Too. I made some revisions, which are not intended to forestall this discussion; frankly, I was afraid I would screw up the formatting if I tried to put them here with highlighting, etc., as WWB Too did.  Among other things, these revisions are intended to clarify the concerns about hedge funds' use of leverage and the size of the industry.
 * With respect to WWB Too's suggested addition: I think this is good stuff and should be added, but it properly goes in the second paragraph, not the third.  If there is no objection, I'll go ahead and put it in there (or someone else can).  John M Baker (talk) 18:11, 17 July 2013 (UTC)
 * Hearing no objection, I've made the addition. John M Baker (talk) 14:50, 18 July 2013 (UTC)
 * One more thing: How would you feel about taking out the fourth paragraph of that section, the one about the FSA surveys?  It's not that it's bad, but I think that what has to be said has been said in the first three paragraphs, and the article is certainly long enough as it is.  John M Baker (talk) 14:49, 18 July 2013 (UTC)

Maybe shorten the fourth paragraph? Its last two sentences sound important. Wildfowl (talk) 21:31, 18 July 2013 (UTC)
 * Suggestion taken. I also updated the cite.  John M Baker (talk) 22:19, 18 July 2013 (UTC)


 * Thanks John, and mea culpa for the delay in following up. I appreciate you using some of the language I offered to improve the section. I'm still looking at ways to improve it, so I may have suggestions to offer regarding it soon. Cheers, WWB Too (Talk &middot; COI) 13:37, 29 July 2013 (UTC)

Suggestion: adding a chart under Performance
I've recently that tracks the cumulative performance of hedge funds over a sixteen year period compared to other investment equities and commodities. I'd like to suggest that this be added to the Performance section of the article, with the caption "Cumulative hedge fund and other risk asset returns, 1997-2012", to help illuminate the discussion in that section. Briefly noted: I'm going to be away from Wikipedia for about a week (to Hong Kong for Wikimania, actually) after today, so if there are any questions or comments, I'll be able to pick up any discussion beginning 8/12. Cheers, WWB Too (Talk · COI) 16:09, 2 August 2013 (UTC)


 * Usually I'm pretty happy with WWB Too's suggested edits, with only minor tweaks, but I don't think I can support this one, which I believe raises a host of issues. (1)  What information are we trying to convey with this chart?  It's not entirely clear to me, unless it's just that some people have made a lot of money with hedge funds, which is a misleading message if presented by itself.  (2) Does it even make sense to talk about the performance of hedge funds as a class?  Hedge funds use a variety of different strategies, with different risk/return characteristics.  (3) Why this particular time frame?  Hedge funds have been a recognized investment strategy for almost a half century.  Is it cherry-picking just to use a recent period when they've done well?  (4) I don't see any sourcing for this information, or even information for what each line is, beyond a potentially confusing abbreviation.  (5) While I tend to think that WP:SYN concerns are overblown, the POV concerns that this chart raises makes me think that this might be an appropriate time to ask if this chart isn't just original research.  John M Baker (talk) 17:57, 2 August 2013 (UTC)


 * John, I'm sorry to hear you're unhappy with this suggestion. My thinking was that this chart would provide a visual way of showing hedge fund performance that would be helpful to readers. I may have to come back to you on the other questions, but regarding the suggestion that the chart is OR, I should note that this is not my own work but a chart produced by J.P. Morgan; after a discussion at WP:IMAGEHELP it's my understanding that it is considered public domain. So far as I understand it, the chart would not be considered OR on Wikipedia unless I had myself created this using figures I had found elsewhere, which is not the case. Anyhow, I do appreciate the speedy response, and I'll follow up again when I'm back in front of a computer. WWB Too (Talk &middot; COI) 20:26, 2 August 2013 (UTC)


 * Thanks, WWB Too; I know it's frustrating to work hard and come up with something, only to draw flak. It's possible that this chart could work with more explanation and context, but under the most favorable view I don't think it's ready for prime time in its current form.  I hope you enjoy your trip.  John M Baker (talk) 21:14, 2 August 2013 (UTC)


 * I am very concerned. The chart was incompatible with what I had remembered from reading The Economist, so I went into its website and typed "hedge fund performance" into its search engine and got this (watch out for pay wall; I can help if necessary) which includes a chart markedly at odds with the above, and says "The S&P 500 has now outperformed its hedge-fund rival for ten straight years, with the exception of 2008 when both fell sharply". The search threw up a number of other articles in a similar vein, including this, which suggests that HF returns should be treated with scepticism. Are we sure that the HFRI Composite index is genuinely representative and not cherry-picked? Wildfowl (talk) 22:05, 2 August 2013 (UTC)

Hi John and Wildfowl, I'm back from Wikimania now and have had the time to review your comments. Taking these roughly in order:


 * John's questions
 * 1) What is the goal of the chart? Simply to show various widely-followed indices of hedge fund performance in a visual format to help illustrate the topic—the same reason we'd include images in any Wikipedia article. Yes, the numbers have trended upward over time, with 2008 as a recognizable exception for most, but that's useful information, too. It can't be POV simply because it shows that hedge funds usually perform well.
 * 2) Does it make sense to talk about hedge fund performance as a class? I'd say that question is answered by the fact that there is already a Performance section in this article; this would just be an addition to it.
 * 3) Why this time frame? Any period of time will be arbitrary to some extent; this is the one Bloomberg and HFR chose, and which is used more than once in the JP Morgan report.
 * 4) What is the sourcing? As noted, JP Morgan cites research by Bloomberg and Hedge Fund Research.
 * 5) Is this original research? As I replied above, no. It's previously published, and not my own work.
 * 6) Could this work with more context? I think it could work with a caption explaining what it is, and I'd be interested to hear what you'd suggest.


 * Wildfowl's questions
 * 1) Why does this look so different from The Economist's chart? Simple enough, they are measuring different things. First of all, the JP Morgan chart shows cumulative returns, as explained in this Financial News article from earlier this year (the paper's website highlighted it as their "Chart of the Day" in June). Second, and importantly, the JP Morgan chart shows risk-adjusted returns, while The Economist shows regular returns. Risk management is a big concern for investors—although I think that goes without saying, this Commonfund report helps to show that—so I think it's fair to say risk-adjusted returns are more meaningful in practical terms.
 * 2) What about HFRI Composite methodology? HFR publishes its methodology here. Publishing indices and analysis of hedge funds is what HFR is known for; after all, they partnered with Bloomberg to produce this research.

If there are any other questions, I'd be happy to consider them. While I see that the initial sentiment runs against including this chart, I really do think that including a visual of this sort would help, and this chart represents publicly-available information as collected and published in cooperation by several well-established industry observers. If a caption needs to be added, or language relevant to the chart should be added to the section for more context, I'm certainly open to that as well. Thanks, WWB Too (Talk · COI) 18:23, 14 August 2013 (UTC)


 * WWB Too, it was not clear to me, and it wouldn't be to any ordinary Wikipedia user, that your chart is risk-adjusted. I would insist that either both risk-adjusted and non-risk-adjusted charts appear, or neither. It is not clear to my why HFRI Composite would be preferable to the HFRX Global index used by The Economist. Also, you have not addressed my other concerns: issues with hedge fund performance reporting, etc. This is looking a lot like hedge fund industry spin, to me. I won't be copying this chart into the article as it is. I think what is needed is a more objective assessment of hedge fund performance, and a more detailed exposition of the issues around it. Wildfowl (talk) 17:35, 15 August 2013 (UTC)


 * Wildfowl, a caption would certainly make clear that it is risk-adjusted, so that's easily dealt with. I'm not opposed to including a non-risk-adjusted chart as well; there's more than enough room in the section for another chart, and better still, the difference between the two could be explained.


 * I think your calling this chart "spin" is misplaced; after all, both charts under discussion now (JP Morgan and The Economist) were compiled by HFR plus a news organization (Bloomberg and Thomson Reuters, respectively). HFR explains the differences between the indices on its website (see here). One difference that is worth noting: the HFRI Composite includes 2200 funds, whereas HFRX Global includes just 60.


 * Lastly, I didn't see a question from you about "issues with hedge fund performance reporting" so I'm not sure how to answer that. best, WWB Too (Talk &middot; COI) 23:25, 15 August 2013 (UTC)


 * The Economist's article here (referred to by me above) mentions a paper by Adam Aiken, Christopher Clifford and Jesse Ellis tackling the problem of self-selection bias ("only the best funds choose to report"). That is one of the issues. Another issue, mentioned by Simon Lack in the first chapter of his "The Hedge Fund Mirage", is that the hedge fund industry has grown, and its best returns were earlier on, when it was smaller. In fact the first words of that chapter are: "If all the money that's ever been invested in hedge funds had been put in Treasury bills instead, the results would have been twice as good." Wildfowl (talk) 18:45, 16 August 2013 (UTC)


 * Hi, Wildfowl. The Performance section already discusses the potential for self-selection bias; in any case, potential flaws with indices is no reason to reject a chart showing what some indices report. Meanwhile, the Lack quote doesn't seem to have any relevance to my suggestion at all.


 * I'm concerned that your response doesn't seem intended to address my previous message. Do you have specific objections to the HFRI Composite? Regarding the risk-adjustment of this chart, would a caption help alleviate your concerns? WWB Too (Talk &middot; COI) 18:09, 19 August 2013 (UTC)


 * I'm still not liking the chart. Frankly, I'd like to see the Performance section shorter, not longer.  This kind of chart would require a lot of explanation, in my view; just seeing it by itself is too confusing.  I still don't feel that I understand the information that we're trying to convey by including the chart.  I also have serious concerns as to whether this particular chart is RS.  The cited source gives me no comfort, with its legend on each page:  "This material is provided by J.P. Morgan’s Prime Brokerage business for informational purposes only. It is not a product of J.P. Morgan’s Research Departments.  For Institutional Investors only. For the intended recipient only."  I don't think we have the right to use this chart, and based on that legend it appears that any use would be inherently misleading.  John M Baker (talk) 22:35, 20 August 2013 (UTC)

I agree that the Performance section needs more work. I hope to make a contribution when I get some time. I will discuss in here before making any changes to the article. It is a difficult area. Bearing in mind the diversity of investment styles, I am not convinced that it is possible to talk about "the performance of the hedge fund industry". Perhaps some text on the issues around measuring performance across the industry is about all that is necessary. Wildfowl (talk) 18:59, 21 August 2013 (UTC)


 * OK, thanks John and Wildfowl for considering the chart. I'll accept that there isn't support for it, and I've closed the request as not done. Best, WWB Too (Talk &middot; COI) 20:20, 23 August 2013 (UTC)

Querying "lightly regulated" in Transparency section
Hello all. Looking over the article recently, and recalling a discussion we had in the second half of last year, there is one mention of hedge funds as "lightly regulated" at the start of the Transparency section, which strikes me as outdated. As those involved in that conversation last year will recall, I'd pointed out that hedge funds have been subject to new regulations in recent years, a fact reflected throughout the text of the article—except in this one place. I would like to see if editors on this page would be willing to amend or remove this language. Let me know what you think about this. Cheers, WWB Too (Talk · COI) 14:52, 21 January 2014 (UTC)


 * I know Dodd-Frank is a big dose of regulation, but maybe number of pages of rules and "heavy" regulation are two different things. How much have the new rules restricted the activities of hedge funds in practice? More pointedly, how much will they have reduced the opportunities for abuse? I am interested to know. Wildfowl (talk) 23:06, 21 January 2014 (UTC)


 * Not so much. The Dodd-Frank Act basically didn't add to hedge fund regulation at all.  It did require managers of large hedge funds to register as investment advisers, if they were not registered already, and to file confidential reports with the SEC on Form PF.  That means that more hedge fund managers are subject to examination by the SEC and have to use an independent custodian, both developments that provide some protection to hedge fund investors, but it doesn't do a lot to add to the regulation of hedge funds themselves.  John M Baker (talk) 23:25, 21 January 2014 (UTC)


 * Thanks for your replies here and sorry for the delay in responding—I've been traveling in the last week. My concern with "lightly regulated" is that it suggests that hedge funds are subject to very little regulation and, as we've discussed before, that's not really the case, more that hedge funds are less regulated than some other investment funds. Also, as John mentioned in our last conversation, hedge funds are regulated more now than they were formerly. Given that, how would you both feel about amending the wording at the start of the Transparency section? Cheers, WWB Too (Talk &middot; COI) 14:48, 29 January 2014 (UTC)


 * If "hedge funds are less regulated than some other investment funds", perhaps "relatively lightly regulated" would be preferable to "lightly regulated"? I wouldn't go any further than that, personally. Wildfowl (talk) 20:53, 29 January 2014 (UTC)


 * Sorry again for the delayed response. I was waiting to receive feedback from MFA before I replied. After reviewing some additional resources, I think that the phrase “relatively lightly” still downplays the regulation too much. I’d like to present some points for consideration.


 * Hedge funds are regulated or influenced by multiple government agencies, including the SEC, CFTC, Treasury Department, Financial Stability Oversight Council, the Federal Reserve, FDIC, National Futures Association, and State Regulators. Their construction and activities are also regulated by the following pieces of legislation: the Securities Act of 1933, Securities Exchange Act of 1934, Investment Company Act of 1940, Investment Advisors Act of 1940, Commodity Futures Trading Commission Act of 1974, Dodd-Frank Act, and the JOBS Act.


 * As John mentioned above, many of these laws, including the Dodd-Frank Act, dictate who may invest in hedge funds and how. Advisers, along with registering with the SEC and filing quarterly reports, are also subject to the new rules governing derivatives, including mandatory clearing, margining requirements, and collateral rules.


 * Together, all this regulates who may invest in hedge funds, how hedge funds may or may not approach those investors, how they can be structured to be considered private pools of capital, how they must report activity to the relevant authorities, and which authorities have oversight over the advisers to the funds. There's more detail in this presentation, if you’d like to take a look.


 * It should also be mentioned that the EU regulates hedge funds as well through directives such as AIFMD, MIFiD, MIFiR, and EMIR.


 * It’s true that hedge funds have different regulations than mutual funds or other investments marketed to the general public, but it's because the investor pools are different. Accredited investors and qualified purchasers who have the knowledge and means to invest in hedge funds are those who typically do. The rules governing the investments are calibrated to reflect that. Perhaps we can find a simple way to make that distinction? Cheers, WWB Too (Talk &middot; COI) 22:14, 7 March 2014 (UTC)


 * Interesting. I don't know enough about this to feel comfortable about changing the article to remove "lightly regulated". You make a great case, but what how strong a case could somebody on the other side of the argument make? Degree of regulation is not necessarily proportional to number of agencies involved, directly or tangentially. What do other people think? Wildfowl (talk) 23:18, 9 March 2014 (UTC)


 * The Transparency section has several issues, it seems to me, of which this is arguably one.
 * "Lightly regulated" is vague, confusing, and arguably POV, since it is not clear just what comparison is being made. It would be accurate to say that hedge funds are "relatively less regulated" than public funds, such as mutual funds and exchange-traded funds.  It would also be accurate to say that hedge funds are structured to largely avoid direct regulation, although their managers may be regulated, and the regulation of hedge fund managers has increased in recent years, particularly in the United States.
 * The text says that hedge funds are not obliged to disclose their activities to third parties. Since many hedge fund managers must make disclosures on Form PF, it would be more accurate to say that hedge funds are not required to publicly disclose their investment activities.  Of course, hedge funds and their managers must make disclosures that apply to investors generally, such as Schedules 13D and 13G and Forms 3 and 4.  The low level of disclosure is a major selling point for hedge funds and is also a major source of criticism.
 * According to the source, the claim of $50,000 for investor due diligence is only for funds that are not well-established.
 * The text says that some hedge funds, mainly American, do not use third parties as their custodian or administrator. Since 2010, American hedge funds managed by registered investment advisers have been required to have qualified custodians, and the hedge funds must either provide audited financial statements or independently verified account statements from the custodian.  I suppose the statement in the main text is still accurate for smaller hedge funds managed by unregistered advisers.
 * The last sentence describes the Madoff Ponzi scheme as a hedge fund. Although Madoff's fraud was sometimes described as a hedge fund, and although it did have feeder hedge funds, it was not itself a hedge fund.  It was a fraudulent broker-dealer.
 * It seems to me that we need to fix all of these issues, not just the "lightly regulated" language. John M Baker (talk) 00:17, 10 March 2014 (UTC)

Of your two suggestions regarding replacing the term "lightly regulated", I prefer explaining that hedge funds themselves are not directly regulated but hedge fund managers are. I also support clarifying the language in the areas you pointed out. Let me know if you would like assistance in drafting new wording to address these issues. Cheers, WWB Too (Talk · COI) 12:55, 17 March 2014 (UTC)


 * OK, I've revised this section, including dumping the mostly inaccurate third paragraph. Let me know your thoughts.  John M Baker (talk) 16:02, 18 March 2014 (UTC)


 * John M Baker, I was surprised that you removed the third paragraph, as it includes mention of Bernie Madoff's scam, which many people thought was a hedge fund. I would have thought that it belongs in a section on controversies. What were the inaccuracies that you spotted in the paragraph as a whole? Wildfowl (talk) 20:23, 18 March 2014 (UTC)

RE: Madoff, many hedge funds are organized as broker-dealers in order to permit various kinds of leverage, trading privileges, or other advantages reserved for BDs. It doesn't seem inaccurate to call Madoff's entity a hedge fund. SPECIFICO talk  21:09, 18 March 2014 (UTC)


 * The primary point of the third paragraph was that some hedge funds, primarily American ones, do not use third parties as their custodian or as an administrator that calculates NAVs. However, SEC rules were changed in 2010 and, except for a few smaller hedge funds, U.S. hedge funds now are required to use a qualified custodian, and either that custodian must send statements directly to investors or the fund must have audited financial statements.  The paragraph's basic point, that a failure to have an independent custodian may result in conflicts of interest and frauds, is therefore no longer well-taken, although historically it was accurate.  While I suppose it is possible that we could devote a couple of sentences to this change, the article is so long already that I would prefer just to see the discussion cut.
 * The paragraph backed this up with two examples, the relatively obscure International Management Associates fraud and the famous Madoff fraud. Although unknowledgeable commentary has referred to Madoff's operation as a hedge fund, it was not.  While it is true that some hedge funds are organized as broker-dealers, these entities are dealers that invest as principal in securities as a trade or business, and investors have ownership positions in the broker-dealer.  In Madoff's case, Bernard L. Madoff Investment Securities was acting as a broker (an agency relationship) and investment adviser.  It did not purport to be a hedge fund, nor was it acting as one in reality.  If we do need to talk about Madoff, I don't think this is the place to do it.  John M Baker (talk) 23:15, 18 March 2014 (UTC)


 * I am still unhappy with the exclusion of Madoff from the article. Reasons:
 * "Hedge fund" is not a precise term, and Bernard L. Madoff Securities LLP looked closer to a hedge fund than any other type of entity (admitting that Bernard L. Madoff Investment Securities LLC – note the difference – was a broker/dealer).
 * Although it was in fact a Ponzi scheme, it will have looked like a hedge fund to "investors", especially since it had feeder funds, as many hedge funds do.
 * The article Madoff investment scandal mentions "hedge fund" 18 times.
 * Articles in the press etc after the Madoff scam came to light have frequently used the term "hedge fund".
 * For these reasons, I would vote for this to be re-inserted. Wildfowl (talk) 21:16, 21 March 2014 (UTC)
 * There's no doubt that Madoff's scheme was organized as a hedge fund in the manner of its subscriptions and formal organization. There are numerous sources which call it a hedge fund.  Is the counter-argument that, because it was not actually investing its capital, we should not use the same name as an identically configured fund which was actually trading and investing?   That doesn't seem persuasive to me.   SPECIFICO  talk  21:50, 21 March 2014 (UTC)
 * I've re-instated the relevant paragraph pending debate in here, since, as far as I can remember, it was removed without debate in here. Wildfowl (talk) 21:16, 22 March 2014 (UTC)
 * It's not really true that this was removed without debate. As you can see by reading above, I listed the problems with the paragraph and was encouraged to fix them.  It now appears that the issue was not settled and people still want to see a version of this information.
 * As far as Madoff is concerned, it is true that some people have referred to his operation as a hedge fund - wrongly, in my opinion, as it never actually purported to be a hedge fund, but instead pretended to be a legitimate brokerage operation. I would be okay with calling it "a fraudulent broker-dealer that is sometimes referred to as a hedge fund," or words along those lines.  Since the main point of the paragraph is that some U.S. hedge funds had affiliated custodians, facilitating frauds, I think we need to mention the 2010 reforms.
 * I acknowledge that "hedge fund" is not a precise term. I don't think there is any basis for the suggestion that Madoff's scheme was organized as a hedge fund in the manner of its subscriptions and formal organization. I also don't think that there was ever any such entity as Bernard L. Madoff Securities LLP, although there are some references to that name on the web.  John M Baker (talk) 22:14, 22 March 2014 (UTC)
 * I guess the test of whether the Madoff entity was a broker-dealer or a fund would be whether (a) all its "investors" had different portfolios invested with it, or (b) they were all invested in the same set of securities that went up and down in price in the same way. My understanding was that it was the latter, hence my feeling that the "investors" thought they were in a hedge fund. As for the affiliated custodians matter, question: by "2010 reforms", do you mean Dodd-Frank? Wildfowl (talk) 22:44, 22 March 2014 (UTC)
 * If you're going to use that test, then you're taking the position that a wrap account is a hedge fund, which is distinctly a minority view. (Incidentally, that's an incredibly weak article.)  By 2010 reforms, I meant both Dodd-Frank and the SEC's requirement that private funds use qualified custodians.  John M Baker (talk) 23:37, 22 March 2014 (UTC)

John – (1) OK, I had forgotten about the "feeder accounts" in the Madoff case, which I assume are what you call "wrap accounts". The former name makes more sense to me. As I understand it, the typical Madoff "investor" placed money in one of the feeder funds, and these fed into a master fund. It was still seen as a fund though, even if rotten on the inside. Feeder funds are typically used to make a hedge fund investment more liquid, yes? (2) It looks as if we need to rephrase the sentence about affiliated custodians. I will have a think about that. Wildfowl (talk) 14:35, 23 March 2014 (UTC)
 * Well, we know that some "hedge funds" are broker-dealers. We also know that Madoff was, earlier in his career the manager of a successful broker-dealer in the so-called "third market" for listed US securities. SPECIFICO  talk  14:44, 23 March 2014 (UTC)
 * Yes, SPECIFICO, I still suspect most Madoff clientele thought the money was going into a well-managed fund; the fact that it was (or was associated with) a broker-dealership may even have persuaded some that his spectacular results came from gaming a conflict of interest between fund and brokerage, e.g. front running.
 * John, I tried to research the 2010 SEC rule on custodians – is this (the second item, dated Dec. 30, 2009) the right thing? Wildfowl (talk) 15:16, 23 March 2014 (UTC)
 * In his broker-dealer activity, Madoff was never handling agency business (brokerage which might have a conflict) but always was acting as dealer. Of course the large, well-known brokerages who routed public orders to Madoff's third market dealer may have had a conflict of interest.  Oddly, that's never been discussed in the press as far as I'm aware.  SPECIFICO  talk  15:29, 23 March 2014 (UTC)
 * Wildfowl, yes, that's the rule. It was published in the Federal Register in 2010, hence my mistake on the date.
 * Feeder funds are not wrap accounts. A wrap account is an account that is held in a brokerage account and managed by an investment adviser (typically but not always the same entity).  Usually all the investors have their assets invested the same way, except to the extent that investors give specific instructions (e.g., no tobacco stocks).  Most wraps accounts are structured to comply with the safe harbor in Rule 3a-4 under the Investment Company Act of 1940.  A true wrap account involves payment of a flat fee that covers both brokerage and asset management, but this is not necessary for the Rule 3a-4 safe harbor to be available.  Presumably Madoff's investors supposed they had an arrangement like this.
 * Specifico, routing public orders in this manner is called payment for order flow and is fairly controversial. John M Baker (talk) 18:32, 23 March 2014 (UTC)
 * Having read Henriques' book (see new citation in article) on the Madoff fraud, I now understand it a lot better, and I have adjusted the article accordingly. For the record, his faux-fund was not a classic hedge fund, but was frequently loosely referred to as such, and looked like a hedge fund to people investing via the feeder hedge funds in the later years of the scam. Wildfowl (talk) 21:36, 29 March 2014 (UTC)

More thoughts on Madoff and Wright
As it seems like the discussion about the Madoff case has finished, I would like to return to John's other points about this paragraph. I would argue to remove the phrasing "some hedge funds, mainly American, do not use third parties either as custodian of their assets or as their administrator" unless it can be cited. I can't find evidence that any fund has direct custody of its assets—either a broker or bank always acts as a custodian.

In addition, it isn't the structure of hedge funds that opens them up to fraud as the language implies, rather, it's an issue of verification. Madoff used the son-in-law of a long-time friend as an auditor and Wright either didn't have one or made one up. In both cases, fictional reports were created and not checked by a credible auditor. While auditing is not enforced, it is a best practice for investors to inquire about the auditing of financial statements prior to investing. According to information released by the SEC, "[a] hedge fund typically has third parties who provide various services to the fund, including a prime broker, an administrator, an outside accountant that audits the fund’s financial statements, and possibly a valuation agent. You should consider contacting these third party service providers to check the accuracy of information provided to you by the hedge fund and its manager." The SEC has instructed investors to ask for financial statements and examine their credibility, because of the frauds that are included as examples in that paragraph.

How do other editors feel about replacing the paragraph with the following (below)? I've added two new sources to support the first sentence. One is an article from Risk and the other article was published in Bloomberg and references the Wright case. I've also revised the sentence about Madoff's case. I realize there has been plenty of discussion about whether or not it was a hedge fund, but here is another source that states that it is not that I'd like editors to consider. Perhaps, as well, a sentence can be added at the end of this paragraph noting SEC changes post-Madoff.

In addition, some minor style notes: I suggest changing "a recent example" to "the mid-2000s" and "has been" to "was" to avoid WP:RECENT issues re: the Wright case. And Madoff's business "incorrectly thought to be a hedge fund" would be more accurately explained as "incorrectly described as a hedge fund", so I've made those changes as well.

Does that cover the issues you mentioned sufficiently, John? What do other editors think? Cheers, WWB Too (Talk · COI) 14:17, 30 April 2014 (UTC)


 * Well, I like these changes, although I never wanted to describe Madoff's scheme as a hedge fund anyway. In the last sentence, I would change "allow for surprise audits" to "require surprise audits."  I would also be inclined to cite to the SEC's adopting release rather than a news report.  If you want a reliable source to support the assertion that Madoff did not have a hedge fund (although hedge funds were involved as feeder funds), here's one.  John M Baker (talk) 15:03, 30 April 2014 (UTC)


 * WBB Too, presumably the text above is to replace only the last paragraph of the Transparency section under "Debates and controversies". Also, do you have a source for: "While auditing is not enforced ..."? Will think more about proposed changes later. Wildfowl (talk) 23:55, 30 April 2014 (UTC)


 * Have thought more, and:
 * (1) I assume that it is the paragraph "Some hedge funds, ... channelled money to it." that you propose to replace.
 * (2) I agree that the words "some hedge funds, mainly American, do not use third parties either as custodian of their assets or as their administrator" should go if it's not right.
 * (3) I had already seen your Street ID source when I adjusted the Madoff wording, and I took it into account along with other evidence. Enough said on that, surely.
 * (4) Madoff was investigated six times, I think, by the SEC, to no avail, so I am a bit skeptical of the protection provided by "surprise audits of the custodians". Admittedly I can't think of a way of faking custody of assets, but, hey, I'm not a dodgy hedge fund manager! Anyway there is no error in your wording there I guess.
 * (5) Conclusion: I can see no objection to your revised wording.
 * (6) I am still interested in "... auditing is not enforced ...". There is some stuff in the article in section "Structure" about audit which kind of implies that. I was wondering what the rule was and where one could find a citation. Perhaps we need a new section on vetting / due diligence.
 * Wildfowl (talk) 22:29, 1 May 2014 (UTC)


 * P.S. Don't forget John M Baker's suggestions above. Wildfowl (talk) 22:38, 1 May 2014 (UTC)


 * As for "auditing is not enforced": In the United States, there is an audit requirement for hedge funds managed by registered investment advisers (which is most of them, and all of them whose advisers manage assets of more than $150 million), which I will describe below.  I don't know if Cayman Islands and other offshore hedge funds are subject to an audit requirement or not.
 * Here's the current requirement, which was added in the 2009 rulemaking I linked in my previous comment. Hedge fund managers have an alternative.  (1) They can have a full annual audit by an independent accountant that is overseen by the Public Company Accounting Oversight Board.  Audited financial statements must be distributed to investors within 120 days of the end of the fiscal year.  Most hedge funds go with this alternative.  (2) Or, the custodian must be subject to an annual surprise verification of client assets.  If this alternative is selected, the custodian must send fund investors quarterly account statements.  In either case, assets must be maintained with a qualified custodian.
 * I think we need to revise the last sentence of WWB Too's proposed wording to be consistent with this, but I don't think we need to get into this level of detail. Any suggestions?
 * Wildfowl, as to your point (4): The SEC's six or so investigations were ineffective because they were not designed to confirm that Madoff actually held the assets he purported to hold.  (SEC procedures have since been revised, of course.)  The key regulatory shortcoming was that his auditor did not conduct full audits, which would have verified the assets.  The 2002 Sarbanes-Oxley Act actually had required broker-dealer auditors to be subject to PCAOB oversight, but at the industry's request the SEC granted a series of waivers to this requirement.  Had the SEC not granted those waivers, Madoff's fraud would have come to light years earlier.  The waivers came to a swift end after Madoff was arrested.  You would think that the Marty Frankel fraud, which also used a broker-dealer that held fake assets, would have revealed the need for full audits of broker-dealers with custody of assets, but it took the Madoff case to make this happen. John M Baker (talk) 01:00, 2 May 2014 (UTC)


 * Thanks for that, JWB. I agree that WWB Too's last sentence needs adjusting; I'll leave it to him and you as I am off on a trip for a few days. Since a lot of HFs are registered in the Cayman Islands, the "Other" subsection of the "Regulation" section is looking a bit light. Also there is no mention of audit under "Regulation" but only under "Structure", which seems a bit of an omission. And, oh by the way, one of the Madoff SEC audits (in late 2005 and 2006, I think) was explicitly looking for a Ponzi, but still failed! Wildfowl (talk) 21:32, 2 May 2014 (UTC)


 * The SEC's oversight of Madoff was, of course, indefensible. It appeared to have started with the premise that Madoff was a legitimate businessman, so there was never any real investigation of other alternatives.  However, Madoff was a great learning experience for the SEC, in a way that Marty Frankel was not.  The SEC always knew that Frankel was a crook, so learning that he was dishonest apparently did not teach the SEC anything.
 * How's this for the last sentence of WWB Too's new language: "Following the Madoff case, the SEC adopted reforms in December 2009 that required hedge funds managed by registered investment advisers to have their assets in the custody of a qualified custodian and subjected them to an audit requirement."  John M Baker (talk) 22:03, 2 May 2014 (UTC)
 * Since the new language seems a pretty clear improvement, I'm going to go ahead and add it to the article. We can still make further revisions if anyone wants further changes.  John M Baker (talk) 03:43, 4 May 2014 (UTC)
 * No probs. Wildfowl (talk) 19:43, 4 May 2014 (UTC)

Your edits look great, John. Thank you both for working through this. I just posted a few suggestions to Wildfowl's thread below regarding the article's lede. Looking forward to discussing those changes next. Cheers, WWB Too (Talk · COI) 22:26, 5 May 2014 (UTC)

New Secondary Market subsection
Hello all. I just wanted to bring the recently added Secondary market subsection to other editors' attention. The passage sticks out to me as being promotional in content. My guess is that it was created to promote SecondaryLink.com, one of the two websites mentioned in the last sentence. A similar section was also added to the Private equity real estate article mentioning the same website.

Additionally, the information presented is poorly worded and unclear. The subsection doesn't seem to fit under the Structure heading very well. How do others feel about removing this section or moving any pertinent information elsewhere in the article? Cheers, WWB Too (Talk · COI) 14:08, 9 May 2014 (UTC)


 * I agree and have taken it out. I would be okay with putting most of it back in, if it were properly sourced.  John M Baker (talk) 14:52, 9 May 2014 (UTC)


 * Right on, glad you agree. WWB Too (Talk &middot; COI) 16:01, 9 May 2014 (UTC)

Lede
I have modified (what is now) the second sentence of the first paragraph of the article, as I thought it needed some attention. In doing so I put "dubious" tags on the two statements made. If anyone has a suggestion for better wording, why not discuss it here? Wildfowl (talk) 20:38, 29 March 2014 (UTC)


 * Thanks for your edits and starting a new thread, Wildfowl. I agree that the wording of the lede could use a few updates. The issue with the first statement you edited is that mutual funds can employ leverage too, but it is regulated and capped, whereas hedge funds' usage of leverage is not capped. Similarly, in the second statement, hedge funds invest in illiquid assets on occasion. To make these distinctions, I'd like to suggest updating the sentence with the following wording and new sources:


 * Let me know what you think. Cheers, WWB Too (Talk &middot; COI) 22:25, 5 May 2014 (UTC)


 * WWB Too, I clicked the second reference and it took me to page 275 of the book, which is all about activist hedge funds and doesn't mention private equity. That doesn't seem right. Wildfowl (talk) 21:04, 10 May 2014 (UTC)


 * Sorry about that, Wildfowl. You're right, the reference should not be to page 275, but 237, as it says in the citation. Here's the updated link that goes to the correct page. The relevant information is under the Comparison with Private Equity Funds and Mutual funds heading. I've fixed this in the markup above. Cheers, WWB Too (Talk &middot; COI) 17:39, 12 May 2014 (UTC)


 * WWB Too, I have just put your text in the article lede. Wildfowl (talk) 19:20, 13 May 2014 (UTC)


 * Thanks for the edit, looks great! WWB Too (Talk &middot; COI) 13:54, 14 May 2014 (UTC)