S. HRG. 109–1051 THE ROLE OF HEDGE FUNDS IN OUR CAPITAL MARKETS HEARING BEFORE THE SUBCOMMITTEE ON SECURITIES AND INVESTMENT OF THE COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS UNITED STATES SENATE ONE HUNDRED NINTH CONGRESS SECOND SESSION ON EDUCATING AND INFORMING THE CONGRESS AND THE AMERICAN PEOPLE ON THE ROLE OF HEDGE FUNDS IN OUR CAPITAL MARKETS MAY 16, 2006 Printed for the use of the Committee on Banking, Housing, and Urban Affairs ( Available at: http://www.access.gpo.gov/congress/senate/senate05sh.html U.S. GOVERNMENT PRINTING OFFICE 48–525 PDF WASHINGTON : 2009 For sale by the Superintendent of Documents, U.S. Government Printing Office Internet: bookstore.gpo.gov Phone: toll free (866) 512–1800; DC area (202) 512–1800 Fax: (202) 512–2104 Mail: Stop IDCC, Washington, DC 20402–0001 VerDate Aug 31 2005 11:35 Apr 08, 2009 Jkt 048080 PO 00000 Frm 00001 Fmt 5011 Sfmt 5011 S:\DOCS\0516PM.TXT JASON COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS RICHARD C. SHELBY, Alabama, Chairman ROBERT F. BENNETT, Utah PAUL S. SARBANES, Maryland WAYNE ALLARD, Colorado CHRISTOPHER J. DODD, Connecticut MICHAEL B. ENZI, Wyoming TIM JOHNSON, South Dakota CHUCK HAGEL, Nebraska JACK REED, Rhode Island RICK SANTORUM, Pennsylvania CHARLES E. SCHUMER, New York JIM BUNNING, Kentucky EVAN BAYH, Indiana MIKE CRAPO, Idaho THOMAS R. CARPER, Delaware JOHN E. SUNUNU, New Hampshire DEBBIE STABENOW, Michigan ELIZABETH DOLE, North Carolina ROBERT MENENDEZ, New Jersey MEL MARTINEZ, Florida KATHLEEN L. CASEY, Staff Director and Counsel STEVEN B. HARRIS, Democratic Staff Director and Chief Counsel JOSEPH R. KOLINSKI, Chief Clerk and Computer Systems Administrator GEORGE E. WHITTLE, Editor SUBCOMMITTEE ON SECURITIES AND INVESTMENT CHUCK HAGEL, Nebraska, Chairman CHRISTOPHER J. DODD, Connecticut, Ranking Member MICHAEL B. ENZI, Wyoming TIM JOHNSON, South Dakota JOHN E. SUNUNU, New Hampshire JACK REED, Rhode Island MEL MARTINEZ, Florida CHARLES E. SCHUMER, New York ROBERT F. BENNETT, Utah EVAN BAYH, Indiana JIM BUNNING, Kentucky DEBBIE STABENOW, Michigan MIKE CRAPO, Idaho THOMAS R. CARPER, Delaware ELIZABETH DOLE, North Carolina ROBERT MENENDEZ, New Jersey WAYNE ALLARD, Colorado RICK SANTORUM, Pennsylvania JOE CWIKLINSKI, Staff Director ALEX STERNHELL, Democratic Staff Director JIM JOHNSON, Counsel DEAN V. SHAHINIAN, Democratic Counsel (II) VerDate Aug 31 2005 11:35 Apr 08, 2009 Jkt 048080 PO 00000 Frm 00002 Fmt 0486 Sfmt 0486 S:\DOCS\0516PM.TXT JASON CONTENTS TUESDAY, MAY 16, 2006 Page Opening statement of Senator Hagel ..................................................................... 1 Opening statements, comments, or prepared statements of: Senator Dodd .................................................................................................... 3 Senator Crapo ................................................................................................... 4 Senator Reed ..................................................................................................... 5 Senator Sununu ................................................................................................ 5 Senator Bunning ............................................................................................... 7 Senator Allard ................................................................................................... 8 WITNESSES Hon. Randal K. Quarles, Under Secretary for Domestic Finance, U.S. Depart- ment of the Treasury ........................................................................................... 8 Prepared statement .......................................................................................... 51 Susan Wyderko, Director, Office of Investor Education and Assistance, Former Acting Director, Division of Investment Management, U.S. Securi- ties and Exchange Commission .......................................................................... 22 Prepared statement .......................................................................................... 55 Patrick Parkinson, Deputy Director, Division of Research and Statistics, Board of Governors of the Federal Reserve System .......................................... 24 Prepared statement .......................................................................................... 61 James Overdahl, Chief Economist, U.S. Commodity Futures Trading Commission ........................................................................................................... 25 Prepared statement .......................................................................................... 65 Hon. Richard McCormack, Senior Advisor, Center for Strategic and Inter- national Studies ................................................................................................... 34 Prepared statement .......................................................................................... 68 Dr. Adam Lerrick, Visiting Scholar, American Enterprise Institute .................. 36 Prepared statement .......................................................................................... 81 Kurt Schacht, Executive Director, Center for Financial Market Integrity, Chartered Financial Analyst Institute ............................................................... 38 Prepared statement .......................................................................................... 83 James Chanos, Chairman, Coalition of Private Investment Companies, Presi- dent, Kynikos Associates ..................................................................................... 40 Prepared statement .......................................................................................... 86 John Gaine, President, Managed Funds Association Prepared statement .......................................................................................... 96 (III) VerDate Aug 31 2005 11:35 Apr 08, 2009 Jkt 048080 PO 00000 Frm 00003 Fmt 5904 Sfmt 5904 S:\DOCS\0516PM.TXT JASON VerDate Aug 31 2005 11:35 Apr 08, 2009 Jkt 048080 PO 00000 Frm 00004 Fmt 5904 Sfmt 5904 S:\DOCS\0516PM.TXT JASON THE ROLE OF HEDGE FUNDS IN OUR CAPITAL MARKETS TUESDAY, MAY 16, 2006 U.S. SENATE, SUBCOMMITTEE ON SECURITIES AND INVESTMENT, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, Washington, DC. The Committee met, pursuant to notice, at 2:21 p.m., in room SD–538, Dirksen Senate Office Building, Senator Chuck Hagel (Chairman of the Subcommittee) presiding. OPENING STATEMENT OF SENATOR CHUCK HAGEL Senator HAGEL. Good afternoon. Today’s hearing will focus on the role of hedge funds in our capital markets. The intent of this hearing is to educate and inform the Congress and the American people on this growing sector of our financial markets. According to the Economist Magazine, a hedge fund is defined as a managed pool of capital for institutional or wealthy individual investors that employs one of various strategies in equities, bonds, or derivatives, attempting to gain from market inefficiencies and, to some extent, hedge underlying risks. Charles Mingus, an American jazz bassist and composer once said, quote, making the simple complicated is commonplace. Mak- ing the complicated simple, awesomely simple, now, that is cre- ativity, end of quote. Suffice it to say we are looking for creativity from our witnesses today. Alfred Jones is credited as the father of hedge funds. He estab- lished the Jones Hedge Fund in 1949. Roy Neuberger and Ben- jamin Graham are also credited for laying the foundations for the industry; however, hedge funds did not begin to gain popularity until the 1960s. In 1969, almost 200 hedge funds managed $1.5 bil- lion in assets. Since then, the growth of the hedge fund industry has exploded, with most of the growth occurring in the past decade. Currently, over 8,000 hedge fund managers are controlling over $1 trillion in assets. Today’s hearing will look at the benefits and risks of hedge funds to investors and to our economy. We will explore the current over- sight of hedge funds, the level of transparency, the different types of investors, and the cause for the explosive growth of this industry over the last decade. The hearing will also examine the current dy- namic of the over-the-counter derivatives market and assess the growing risks and benefits of this industry. We will look at the types of derivatives offered, the main users of derivatives, potential concerns for investors, and the industry’s impact on our capital (1) VerDate Aug 31 2005 11:35 Apr 08, 2009 Jkt 048080 PO 00000 Frm 00005 Fmt 6633 Sfmt 6633 S:\DOCS\0516PM.TXT JASON 2 markets. And finally, we will consider whether the Federal Govern- ment should play a greater oversight and regulatory role in these areas and also assess the risks of overregulation. In today’s global economy, large amounts of money can be trans- ferred in a moment’s notice, and it is important that our investors have confidence in the systems and funds that transfer and admin- ister their investment and assets as well as a good understanding of both their investment benefits and risks. Just as important is keeping our capital markets here in the United States strong and dynamic and the envy of the world. I welcome our witnesses today, who will help us explore these important issues. Our first two panels feature representatives from the President’s Working Group on Financial Markets. We will look at the work of the President’s Working Group on this issue. Our first panel includes the Hon. Randal K. Quarles, Under Secretary for Domestic Finance at the U.S. Department of the Treasury.