New 'best practices' urged for giant hedge funds

WASHINGTON—Managers of hedge funds would have to improve the operating procedures of the giant pools of capital in such areas as transparency and risk management under new proposals offered Tuesday.

Two advisory groups assembled by the Bush administration proposed new "best practices" for the hedge fund industry, but a leading critic attacked the effort as falling far short of the mandatory government regulations that are needed.

One set of the recommendations was prepared by hedge fund managers and the other was put together by investors who use the funds.

Treasury Secretary Henry Paulson said the recommendations would send "a strong message that heightened vigilance is necessary and appropriate and that all stakeholders have an important role to play."

However, Richard Blumenthal, attorney general of Connecticut, the home for many hedge funds, said the voluntary guidelines were a "virtual farce" that would do little to halt abuses in an industry that has seen explosive growth with assets now close to $2 trillion in an estimated 8,000 funds.

"Hedge funds have become too big and too important to remain outside the rules," Blumenthal said in a statement. "Instead of voluntary guidelines, the federal government should set specific, common sense rules and provide for federal and state enforcement."

The release of the guidelines comes at a time when a severe credit crisis has roiled financial markets with many large banks and investment houses being forced to declare billions of dollars in losses. Hedge funds have been caught up in the turmoil as investors have grown worried about the solvency of funds that invested heavily in securities backed by subprime mortgages, where delinquencies have hit record levels.

Hedge funds, which operate with little government supervision, cater to institutional investors and very wealthy individuals. However, millions of ordinary people have also become unwitting investors in the funds through their pension plans.

In early 2007, a presidential working group headed by Paulson rejected the idea that the funds needed increased regulation and said what was needed was improved voluntary standards for both fund managers and investors.

In unveiling the recommendations of the advisory groups on Tuesday, Paulson said the administration was not endorsing the status quo but rather pushing for improvements that would keep U.S. financial markets competitive in a global economy.

Sen. Charles Schumer, D-N.Y., a key voice on financial matters in the Senate, said that Congress was just beginning to examine what needs to be done in the wake of the severe credit crisis but "in the interim these best practices should strengthen the hedge fund industry and provide investors and regulators with better information."

The credit crisis claimed its biggest victim last month with the near-collapse of Bear Stearns, the country's fifth largest investment bank, which was taken over by JP Morgan Chase & Co. in a deal in which the Federal Reserve provided a $30 billion loan.

Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee, said in an interview with The Associated Press on Tuesday, that he expected Congress -- not this year -- but in the future to revamp financial regulations to better keep pace with financial innovations such as the growth in hedge funds.

The set of guidelines for investors was drawn up by an advisory panel headed by Russell Read, the chief investment officer of the California Public Employees' Retirement System (CalPERS), the largest pension fund in the United States.

The other set of recommendations for hedge fund operations was draw up by an advisory panel headed by Eric Mindich, the head of Eton Park Capital Management, a large hedge fund.

Mindich said in an interview with The AP that the effort was intended to "raise the bar" for the industry. He said the proposals could be modified based on comments received during an upcoming 60-day comment period.

In a spectacular hedge fund failure, Amaranth Advisors lost $6 billion in the fall of 2006 because of bad bets on natural gas prices. Read told reporters at a briefing that Amaranth was the "poster child" for what the advisory groups were trying to guard against by proposing a set of best practices.

"I think this represents a coming of age for the hedge fund industry," Read said.

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Associated Press writers Marcy Gordon and Jeannine Aversa contributed to this report.