Should Regulators' Audits Be Geared to Finding Ponzi Schemes Like that of Madoff?

No, no link. You're probably tired of reading all those Madoff stories already. And the other guys, Nadel, Cosmo, et al.

I believe it is fair to say that the SEC and the states' routine compliance audits focus on routine and rather mundane procedural compliance matters. Do you have the proper files, are they current, do you avoid various specific fiduciary or suitability no-no's? Have you done whatever the last guy to hit the newspapers and embarrass the agency was guilty of doing? I other words, are you honest but guilty of sloppy record-keeping? Are you guilty of whatever the latest hot-button issues are?

I would submit that it would be a good and reasonable goal to get beyond that kind of predictable bureaucratic thinking. A suggested goal, which would require legislation and funding: In the types of investment vehicles where Ponzi-scheme bahavior has occurred, regulate them. Require the types of accounting and other controls under discussion. Third-party, arm's-length portfolio valuation and client reporting. If portfolio holdings are illiquid or unmarketable, require regular, more frequent disclosure, and conservatively value them. If that impacts fees, too bad! Audit them. Regularly. And make those auditors utterly independant of political interference.

Here's an idea the hedge funds will just love! Tax them to pay for the cost of regulating and auditing them to keep them clean.

So, what do you think? Should SEC and other regulatory audits of entities such as hedge funds be designed to do this, to get beyond the usual regulatory issues, to do more, to reasonably minimize the opportunities of men like Madoff and these other bad actors we've been reading about to hurt good people and wonderful charities?

WSJ: Goldman Hedge Fund Had Worst Month in August

"For years, Goldman Sachs Group Inc.'s flagship Global Alpha hedge fund could do no wrong. Over the past year, it has been able to do almost nothing right."

"August was the worst month in the fund's 12-year history; it was down 22.7% last month alone, according to a recent letter to investors. So far this year through the end of August, it was down 33.4% due to bad bets on everything from the Australian dollar, the Norwegian stock market and Japanese government bonds. The letter gave no indication about how the fund was faring this month. Over the past 12 months, the fund has lost 37% of its value."

Ouch.

For those who do not know the difference between speculation and investing, this sort of result may provide a useful opportunity for review, as they at least look more like an example of speculation than of investment, and of what happens when speculation goes awry. Money vaporizes, for one thing.

Speculation, per Investopedia, is "The process of selecting investments with higher risk in order to profit from an anticipated price movement." Further... "Speculation should not be considered purely a form of gambling, as speculators do make informed decision before choosing to acquire the additional risks. Additionally, speculation cannot be categorized as a traditional investment because the acquired risk is higher than average." And, reading on, "More sophisticated investors will also use a hedging strategy in combination with their speculative investment in order to limit potential losses."

I would go further, and say that there is not really even such a thing as a "speculative investment". It is sort of an oxymoronic usage. It is a speculation or it is an investment. And the reference to use of "hedging strategy in order to limit potential risks" is a bit ironic, as we're looking at a hedge fund, like many others, which has seem its efforts at risk control overwhelmed by market events.

"Investment", remarkably, is not defined in Investopedia! You might best define "investment" by a reading of chapter 1. of Benjamin Graham's classic work The Intelligent Investor.

I guess you might say the difference is indifference!

Relative indifference to risk, and greater willingness to accept more of it, are characteristic of the speculative, er, speculator. I said relative! Risk is always there, as even Graham would have admitted. There is such a thing as an aggressive investment, and an agressive investor, but the aggressive investor has tied his approach to his goals, and has pretty serious policy controls on the degree of acceptable volatility. A willingness to accept relatively greater levels of risk, with relatively poorer compensation for bearing that risk, or less knowledge of the actual risk taken, is associated with speculative commitments of money. In terms of equities, investors seek more compensation for bearing risk through such things as revenue streams (dividends) and lower prices for access to growth in earnings. A mere hope that the share price will go up or down based on expected short term developments is a speculative approach, for example. For example, using this view of the terms, just about everything I have ever seen Jim Cramer suggest is speculative, not investing.

Bottom line: In what sense is a commitment of money to a hedge fund an investment? If, as has already been said by someone other than me, the 'best and brightest' in the business cannot run a hedge fund without results like this, then who can?

(the story is $ subscription only)
Goldman Hedge Fund Had Worst Month in August - WSJ.com

Retirement Funds Vanish as Bankruptcies Hit Tax-Deferred Scheme : Bloomberg's Erik Larson

The story is about an intermediary and some section 1031 exchanges gone very bad. Money not there. Now I'm neither a CPA nor a tax practitioner. From a very general investment and personal finance perspective, what are the lessons?

Businesses built around the tax code's loopholes can turn out to be very poor places to put your money. There must be a "valid business purpose" somewhere in there. I'm not just talking about such a business purpose for IRS purposes, but for investment purposes, such as "has this thing made money?" and "has it ever paid back the investors' principal?". When a very big tax loophole gets lobbied into existence, legitimate businesses will be built which also accommodate it, and then sometimes more exploitative types come in, for the big, quick bucks which might be hustled. No specific characterizations of such intended here, but generally, it should always be a concern if it is your money that is involved. When the tax consequences of a transaction, or a use of a specific intermediary look to you, as a lay person, to be the key drivers, rather than the making of a profit or gain, then, caveat emptor.

Another lesson, for business owners such as the person mentioned in the story, is to surround yourself with reputable people, to run something like the transaction described in the story by both your lawyer and accountant, and listen to them.

Seek real diversification, not just apparent diversification, when you can. If one thing goes very badly, will you be washed up?

Finally, if in a situation somewhat like the one in the story, if there is not a way to get the favorable tax outcome you would prefer, a way which passes the "smell" test, look for a fall-back approach, perhaps a less aggressive approach, with a still pretty good outcome. Beware people giving you a hard sell on some sure-fire tax-avoidance scheme, which just happens to compensate them handsomely. Ask how they are compensated! Demand specific written disclosure! The proposed actions might look like tax evasion, not tax avoidance, to the authorities. There's a world of difference. Even when the "intermediary" doesn't lose or steal your money.

Bloomberg.com: Exclusive

Bloomberg's strangest headline of the day, "It's Time to Meet the Subprime Devil We Don't Know: Caroline Baum"

Is this perhaps a slightly awkward headline? I always figured she was perfectly nice. (Just kidding now.)

Seriously, she has a very substantial point: Is the lack of transparency which goes with certain investments such as some mortgage-backed securities, sufficient to make it very difficult to evaluate the risks present in the financial markets? Sufficient to render problematical proper evaluation of the risk present in heavily-leveraged, quantitatively-driven portfolios of such investments? Evidently.

Sufficient even perhaps to alter the "riskiness", i.e., volatility, of even other asset classes? In the short run, apparently. Did Stephen King ever write anything as scary as that?


Bloomberg.com

Subprime lender CompuCredit's nearly $90 million "tied up" at Horizon hedge fund which has blocked withdrawals: NY Post

Interesting reading. "CompuCredit will have to settle for only a percentage of its cash coming back. "

A remarkable comment near the bottom of the article: "Other investors biting their fingernails over the fate of Horizon include several hedge funds that invested with the fund as a way to park excess cash for several months." Now that's a first for me. I had no idea that anyone in their right mind would "park" excess cash in a highly volatile vehicle such as a hedge fund. A rule of thumb for sane investors: Do not expose short-term money to market volatility! If the intent was a deliberate short-term commitment of funds to that investment, while considering other investment opportunities, then, well...




LENDER'S $90M HIT IS ON 'HORIZON' | By RODDY BOYD | Business News | Financial | Business and Money

HEDGE DOUGH NO GO FUND $$ DRY UP -- NY Post

I just loved that headline. Whatever happens to the NY Times, there will always be a Post. The margin terms, they-are-a-changing. From one extreme to the other, it seems. Is it possible that the market can sort of fix its' own problems, without the politicians riding in like the Texas Rangers?


HEDGE DOUGH NO GO FUND $$ DRY UP | By RODDY BOYD | Business News | Financial | Business and Money

Index Universe: Hedge Fund Index Debacle

Good discussion of the problem of hedge fund indexes and their "numbers". Failures such as the most recent, not including the Bear Stearns funds' numbers, which were sort of, well, you know, hard to put together, is not the the only problem. The author, Matthew Hougan suggests that even when there is no gross breakdown in such an index, the performance numbers are not going to be exactly "real-time" in nature, but have something of a "serial correlation" issue. As my daughter might perhaps say, "Ewww".


Breaking News - Hedge Fund Index Debacle

'Barclays may sue to recover losses at Bear Stearns' -- MarketWatch

Barclay's was an investor at the now-worthless Bear Stearns' High-Grade Structured Credit Strategies Enhanced Leverage Fund? Well, for Pete's sake. They were also a lender to the fund. A conflict of interest? And they are suing to get their investment back? As a lender, would you expect then to have had more or less information about the status of the fund than the retail investors? This will be interesting to watch.

Also, per a WSJ subscription-only article, Barclays Spars Over Its Losses at Bear Stearns it now seems that some of the investors were not happy with what turned out to be pretty radical levels of leverage employed at the fund, but were trying to juice the returns by borrowing part, perhaps half, of their investment in the fund from a bank. In essence, investing in a hedge fund on margin. I personally just have a hard time working up much sympathy for anyone who would treat their own money with such contempt. How could anybody do that?


Barclays considers options for recovering losses at Bear Stearns - MarketWatch

Bear Stearns Warns Hedge Fund Investors of Total Loss -- Bloomberg

Yuck. Total. Loss. Well-hedged, all right. Let's see. SPY, which is about as "plain vanilla" a thing as there is in an investment, is up 27.56 percent over 1 year, according to MarketWatch. Well, I'm sure that the reps who sold these funds to the clients really feel for them. Perhaps they'll take up a collection out of their bonus checks to send out a card. Not to be too negative all the time, but something just stinks about stories like this.

Do not buy investment crap. Perhaps, if you are being pitched a hedge fund soon, you should just write the preceding sentence one hundred times.


Bloomberg.com: Worldwide

Hedge Fund Manager, Fugitive Berger of Manhattan Investment Fund Caught in Austria

Good! Now let justice be done.


Bloomberg.com: Worldwide

How Not to Invest! "Econ Prof loses $134 million" & falsifies reports to clients....

A timely loss of memory: "According to a suit filed by the Securities and Exchange Commission last week, the reports that investors received were false and the money invested — about $134 million — is almost all gone. As SEC investigators attempted to question Parish, he claimed to be suffering from amnesia and checked himself into a hospital".

Please, please, please, people, do not ever invest in as gullible a fashion as this man's poor clients. You want to see regular statements from a known third-party asset custodian, or maybe audited numbers in some very few cases. If it just seems too good to be true, it probably isn't. You want to know where the alleged trading is taking place.

From Inside Higher Ed, via Michael Stastny's Mahalanobis Alpha Omega blog