If ever there was an argument for the advertising ban on Hedge Funds to be lifted it is this one. Over the last three years a brazen group of New York scam artists raised about $30 million from unsuspecting investors by posing as principals of a successful hedge fund and then fled with the loot.Investments from $5,000 to $500,000 were obtained from college professors and educated professionals. It took the group a little more than three years, from early 2003 September 2006 to raise the $30 million.
A grand jury empaneled by Michael J. Garcia, the U.S. Attorney in Manhattan, is said to have handed up a sealed indictment in the case, according to a lawyer hired by 10 of the victims, who said that the FBI was investigating the matter.
The criminals are clearly to blame here, however, this is a problem that, in our opinion, is caused in part, by the regulators themselves.
There is a scam out there that is based on “Prime Bank Guarantees” or “Medium Term Notes” that has taken billions from investors with promises of astronomical returns. The SEC web site says:
“Lured by the promise of astronomical profits and the chance to be part of an exclusive, international investing program, investors are once again falling prey to bogus “prime bank” scams. These fraudulent schemes involve the purported issuance, trading, or use of so-called “prime” bank, “prime” European bank or “prime” world bank financial instruments, or other “high yield investment programs” (“HYIP”s). The fraud artists who promote these schemes often use the word “prime” – or a synonymous phrase, such as “top fifty world banks” – to cloak their programs with an air of legitimacy.”
The thing that allows the bogus ‘brokers’ and ‘investment managers’ of this fraud to operate is that they have created a veil of secrecy over the whole operation. The SEC says:
“Promoters claim that transactions must be kept strictly confidential by all parties, making client references unavailable. They may characterize the transactions as the best-kept secret in the banking industry, and assert that, if asked, bank and regulatory officials would deny knowledge of such instruments. Investors may be asked to sign nondisclosure agreements.”
This ’secrecy’ is what perpetuates the fraud. Simply put, the peddlers of this scheme will tell you that when you do your research that you will find everyone denying the existence of the scheme. They will say that those not in the industry don’t about it because there would be outrage that rich people could make so much money and those in the industry will deny it because they either aren’t high enough up or are trying to keep it a total secret. They will also tell you that a minimum investment of $10mn is the norm, but they have split up that $10mn to allow their investors in. The perfect cover. And I speak from personal experience, 15 years ago as an investment pup, to my eternal shame, I got caught in a the same scam.
So we have an ‘investment’ that is supposed to be super secret, has a minimum investment and is not advertised anywhere. Do elements of this ring any bells?
Simply put, the regulators are perpetuating the ’secrecy’ of hedge funds by not allowing advertisement of the funds. Their rules about only being able to invest a certain amount of money did not protect the people in this case who invested $5000, did it? Something tells me the scammers did not check to see what the net worth of the investors was either.
How would advertising funds have helped? As with everything, the fact that advertising is allowed generates an awareness of a particular industry. How many of you knew how to play poker before the online casinos plastered the web with advertising? My limit was ‘Snap’, now I am a stone cold poker shark. (sure – when the anti is 5 Ruppen! – Ed)
By the very nature of advertising and, therefore, informative web sites, brochures etc etc, this kind of fraud would be more difficult to perpetrate because the veil of secrecy would be lifted for all to see.
Of course, there will always be criminal elements who will attempt to subvert whatever rules are out there but the regulators throughout the world don’t need to make it easy by perpetuating a secrecy myth that can be exploited by the criminal element.
OK, let me explain. “Should unsophisticated investors be allowed to invest in hedge funds?”..
No.
and Yes.
But mainly No.
Difficult question. Lets take three examples:
Johny Smart-Pants is a a 22 year old tech wizard who makes $200,000 a year. He has saved $100,000 and decides he wants to take a risk and fancies this hedge fund malarkey. He knows nothing about investments but likes the idea of the risk/reward. If he loses it, he will be mad but not broke.
Should he be allowed to invest? Why not?
Have him sign a waiver saying that he has read all the risks warnings, knows he can lose his money but still wants to do it anyway. Free country right?
Another example, Mrs Daisy Dotes and Mr Dosey Dotes want to invest some money for there little amsey diveys, but are happy to risk some of the funds. They are 65 both retired. He was a stockbroker, she was a housewife who dabbled in the markets and is of intermediate knowledge, he has followed hedge funds, knows the risks and decides he would like to invest.
Should he be allowed to? Probably not… but then again why not if he is happy to take the risk?
Third example.
Mr T.R. Uck-Driver made $10mn from his trucking business. One of his golf club pals told him about hedge funds and he wants to invest $1mn. He knows nothing whatsoever about the stock market..
Should he be allowed to invest?… wait a minute… he can, with nothing more than an accredited investors form…
It’s madness.
We believe solidly that freedom for individuals to invest in whatever they want whenever they want is a paramount pillar of being in a free society, however, there needs to be protections in place, but that is not only the regulators job. It is the fund manager that accepts the money.
A very easy situation to implement would be one where the regulators laid down rules for investment into hedge funds where the sophistication and the circumstances of the client were taken into consideration by the fund before they invest (much like the ‘know your client’ for every other investment). A decision is made by the compliance department of that firm as to whether they take on the client or not. This would be based on many factors, the ability to replace funds lost, age, sophistication, percentage of net worth, etc etc.
Simply saying that someone with over $2mn is OK to invest is just..well…silly at best, dangerous at worst.
I understand that you will get managers whose compliance department is not all it should be and will accept anyone, however, if a client looses money in such a fund then he/she should have the right to recover that money from the fund for negligence. Surely this method would level the playing field for all investors to consider all investments.
Many people don’t know about and don’t care about hedge funds, but are being excluded from accessing funds because they are not rich enough. Why on earth is the principal of this not being discussed? Think about it.
If you want to jump of a cliff with a parachute attached (or not), go bungy jumping off a dam somewhere, or, in Switzerland, legally have an assisted suicide, you can, no problem. But because some bureaucrat says you are not rich enough, you can’t invest in a hedge fund..
In our opinion, whether you want to or not, there should be a right for anyone to ‘apply’ and the fund manager should consider your application and be allowed to accept or deny it on his or her terms. Anything else is as elitist as the the secret fraternities and the London gentleman’s clubs and for countries that claim to have a democracy, it is not very democratic, is it?
