Letter to the SEC

The SEC hosted two days of discussions with hedge fund representatives in May.  At the meeting, fund representatives painted a picture of an idyllic world where all is well.  The SEC, however, wants to hear from the rest of us. It has put out a call for public comment about hedge fund practices.  

The site has sent the following letter to the SEC.  Please use the link at the end to email comments of your own. 

June 19, 2003                             
Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
                                                        RE: File No. 4-476 (Hedge funds)

Dear Mr. Katz:

Thank you for this opportunity to offer views on hedge fund regulation.

Asensio Exposed, a shareholder-run website geared to concerns of retail investors, welcomes the SEC's inquiry. It is nonetheless concerned that the agency is looking for victims where they are least likely to be found. Contrary to the SEC's impression, the individuals most often harmed by hedge funds are not those who invest in them, but those who do not.

The Anthony Elgindy indictment is a case in point. It alleges that:

the defendants . . . and certain subscribers to AnthonyPacific.com and others, were members and associates of an enterprise as defined in Title 18 . . . The chief purpose of the Enterprise was to obtain money for its members and associates by trading on material, non-public information that had been misappropriated from law enforcement databases . . .

The year prior to his arrest, Elgindy described his paying clientele as:

Approximately 250-260, hedge fund managers and a few dozen Licensed professionals and Market makers Including Big Wirehouses.

These managers did not use the misappropriated information to cheat their own customers, but to make money for those clients and themselves. Investors who lacked access to the confidential facts are the ones who were harmed. They incurred losses when subscribing hedge funds and others traded on the misappropriated information.

Practices of Concern

Of course, hedge funds can abuse their investors. But such outcomes appear rare. Funds prosper not by stealing from clients, but by doing well for them. What makes them controversial is evidence that dubious tactics are used to achieve this goal. Among these are:

Trading on material non-public information. Hedge fund analyst reports contain material information, but are often shared only with other funds. This allows networks of funds to combine their buying power and trade on material information not available to retail investors. When short-selling, for instance, a fund can minimize risk by choosing stocks it knows other funds are shorting. Retail investors cannot.

Circumvention of short-sale rule. Many funds use a net short strategy involving both long and short positions in the same stock (with the latter the larger of the two.) When investors are net short, sales of long shares are to be treated as short-sales--to prevent their use as part of a manipulative strategy to force down prices. However, hedge funds (and others) may be using tactics to circumvent the rule and evade selling restrictions, denying investors intended safeguards.

Deceptive position disclosure. Large hedge funds must report their long holdings, but few (if any) funds volunteer information about short positions. This has misled untold numbers of investors, who take increasing institutional presence on the long side as a demonstration of confidence. In fact, it is often the opposite: a sign of a short-selling campaign by net-short hedge funds that will drive prices down.

Some funds reportedly take advantage of undisclosed short positions by presenting themselves to company management or regulators as investors on the long side when they are in fact seeking to depress share price. Secrecy regarding short positions also encourages the dissemination of misinformation about companies and makes locating the source extremely difficult.

Upward manipulation of stock prices prior to short-selling. There is evidence that funds deliberately run up prices of stocks targeted for short-sale in order to maximize downside potential.

Abuse of financial message boards. Certain hedge funds flood Internet boards with messages about stocks in their portfolios. They not only conceal or deny an institutional affiliation, but post rumors and false information calculated to benefit their positions. Posing as ordinary investors, some also contact shareholders and/or the press with such claims.

Several "gurus" dispensing advice on financial sites are reportedly hedge fund managers who use aliases to conceal their identities. Ample grounds exist to be concerned that their advice has been tailored to benefit undisclosed positions.

Manipulation of analyst opinion. Some funds apparently seek to influence prices by arranging for seemingly independent analysts to issue opinions favorable to their positions--opinions that do not disclose the funds' editorial or financial involvement. Funds also appear to engage in trading in anticipation of these pre-arranged reports--again, benefiting from material non-public information.

The Issue of Preferential Treatment

The SEC's lack of attention to such tactics has been frustrating for retail investors.  Some--perhaps many--believe that it permits hedge funds to engage in conduct that others may not. The agency needs to evaluate its enforcement record carefully and ask whether it is truly commensurate with a claim of equal treatment for all.

For example, retail investors strongly support enforcement actions against those who use Internet message boards to manipulate stocks. But they are puzzled when the agency pursues college students and even a teen-ager for such activities while ignoring fund managers who do so on a much grander scale.

Similarly, investors have little patience with conflicts of interest between Wall Street analysts and the companies they cover. But they are again puzzled when the SEC pursues conflicts related to positive recommendations, yet shows no concern with negative recommendations surreptitiously commissioned by hedge funds seeking to benefit their short positions.

A common explanation for this disparity is that the agency sees hedge funds as a key ally in finding fraud--and therefore prefers not to take action against them. Here again, the Elgindy matter is instructive. A second indictment quotes the affidavit of an FBI special agent:

My review of the chat logs revealed that Elgindy frequently stated to his subscribers that he was receiving his information from a source at the FBI. On occasion, Elgindy explicitly informed his subscribers that this information was non-public information and that anyone who shared it would be prosecuted.

The indictment also alleges that Elgindy arranged for subscribers to eavesdrop on a private conversation with the SEC. After they heard it, Elgindy reportedly told them:

[A]lthough there is an official investigation into (name deleted in affidavit) .. it is now classified as Formal and Non public. So it can not be mentioned publicly," . . . Thank You for being so trustworthy with the info i share with you all.

Yet, there is no indication that any of his fraud-savvy hedge fund subscribers contacted authorities to express concern that misappropriation of government information might be taking place. To the contrary, subscribers apparently continued to buy and presumably use the information to enrich themselves and their clients. This sounds less like a group of dedicated fraud-fighters than one that does whatever is in its economic interest. Any appearance of special treatment to such a group is obviously a blow to investor confidence.


Though these problems are serious ones, the solutions need not involve heavy-handed regulation. What is needed is greater transparency of hedge fund operations and more even-handed enforcement of existing laws. Specifically, the SEC should require hedge funds to:

●  Provide the public with equal access to their research or reserve it for in-house use.

●  Report both long and short positions regularly (1).

●  Disclose sponsorship of analyst recommendations.

●  Disclose affiliations and relevant positions when posting on financial message boards or otherwise communicating with the public or news media.

●  Cease practices that permit evasion of short-selling rules.

The agency should also create a mechanism to investigate complaints of selective enforcement and establish procedures to prevent preferential treatment.

There may be a role for self-regulation by the industry in hedge fund reform, particularly in the area of professional conduct. The Commission may want to encourage the industry to develop standards of professional responsibility for its members.


A final point is not specific to hedge funds, yet is unquestionably the most important of all. It is that the free flow of truthful, non-misleading information is the most powerful equalizer of the disparities inherent in free market economies. With it, ordinary investors can achieve extraordinary outcomes. Without it--or if misled by half-truths--they do not stand a chance.

Hedge funds should have the right to offer their services and to express their opinions. But they should not have the right to engage in deceptive practices that mislead investors or facilitate market manipulation. If the industry truly believes that it does nothing untoward, it should have no objection to shining some much-needed daylight on its practices.

(1)  The cost of generating and transmitting a holdings report is so minimal, and its value to investors sufficiently large that disclosure requirements should extend to all funds. Exempting smaller funds simply provides an incentive to keep funds below the size that triggers reporting requirements. This is easily done--by starting new partnerships rather than accepting additional investment.

Page created 6/19/03