Are Hedge Funds Their Own Worst Enemies?

Hollywood movies are a good indicator of what’s up and down in the popular imagination. It hasn’t been hard to notice that the bad guys are no longer mysterious Eastern Europeans (read Communists) but are now typically Middle Eastern and/or “terrorists.”

Money men are increasingly cast as perps. In Blood Diamond, Leonardo diCarprio played one Danny Archer, a smuggler who sold conflict diamonds on behalf of really nasty rebels, but this being a major motion picture, he redeems himself and dies for his sins. In movie version of Casino Royale, the chief baddie, Le Chiffre, changed from his role in the Ian Fleming novel as a sponsor of Communist-backed trade unions to a financier of terrorist organizations.

Expect to see a movie with a hedge fund operator as the lead villain. Hedge funds have been so insensitive to how their actions are seen by outside parties that they are creating their own negative PR.

Now of course, you can blame it on their tragic upbringing. They were never properly socialized, they are kept away from normal human company and instead spend all day in front of computer screens. And they have been trained to focus on every trade, and not think of larger consequences.

Let’s look at a couple of examples this week, the first Northwest bankruptcy case, as reported in Bloomberg:

Hedge funds with stakes in Northwest Airlines Corp. tried to persuade a bankruptcy judge they shouldn’t have to disclose details of their financial interests like everyone else in the case. He wasn’t impressed.

The funds, including Owl Creek Management LP, Northwest’s third-largest shareholder, claimed disclosure would give competitors insight into the funds’ strategies. The group also argued that just as car dealers and home builders don’t tell potential buyers their actual costs, the funds shouldn’t have to reveal their investments.

U.S. Bankruptcy Judge Allan Gropper in New York dismissed the first argument as an “improbable contention.” As for the second, he said in his March 9 ruling, “the committee members do not advance their position when they compare themselves to car or real estate salesmen.” Gropper gave the funds until March 14 to make the information public.

This ruling should have been expected. Bankruptcy is a well established area of the law and when the judge weigh the proposals of various petitioners (the company, any creditors’ committees), he weighs what their economic interest (ie, how much they put in and how far under water they are) and what they stand to gain and lose.

It is almost certain that the hedge fund caviling isn’t just about protecting their precious trading strategies (although the hedge funds are paranoid about having that veil penetrated). They also don’t want it exposed (whether in this case or future ones) that they came in at the last minute, bought a lot of debt at distressed prices, and have a smaller and more transient interest than other players. It would work to their disadvantage.

Now it would be fine if it went this far. But the hedgies really don’t seem to understand the premise that bankruptcy is a legally proscribed process and participants therefore need to follow the rules. If the rules bother you, then don’t get involved. For hedge funds, who choose to buy into these situations, as opposed to most of the other parties, who wind up there by bad luck, should know full well what they are getting themselves into.

However, not only are the hedge funds involved in the deal appealing the decision (to be expected), two industry associations are weighing in on their behalf, simultaneously revealing their dedication to member interests and lack of common sense. From the story,”Wall St Trade Groups See Big Harm From Hedge-Fund Disclosure:”

Two trade associations that count among its members Wall Street’s biggest financial-services firms asked a judge Thursday to reconsider an order forcing hedge funds to disclose trading activity, saying it would do “serious” harm to corporate bankruptcy reorganizations.

In papers filed with the U.S. Bankruptcy Court in Manhattan, the Loan Syndications and Trading Association and the Securities Industry and Financial Markets Association asked Judge Allan Gropper to rescind the order. Gropper last week instructed more than a dozen hedge funds involved in the Northwest Airlines Corp. (NWACQ) Chapter 11 case to disclose how much company stock and debt they bought, and at what price.

The associations said the order, “by requiring the disclosure of proprietary and highly confidential information, will in all likelihood erect a substantial obstacle to the participation of many stakeholders – in particular those sophisticated stakeholders who are the most likely to have the means and the experience to make a positive contribution toward reorganization.”

In other words, financial muscle and modeling skill should take precedence over the rule of law.

A Bloomberg columnist, David Pauly, took a similarly dim view of the hedge funds’ position in his piece, “Since When Don’t Investors Have the Right to Know?

The public markets have a new hero.

He’s a judge in U.S. Bankruptcy Court in New York named Allan Gropper.

Gropper, who presides over the bankruptcy of Northwest Airlines Corp., told a group of hedge funds last week that they should get over themselves.

The funds, including Owl Creek Management LP, the airline’s third-largest shareholder, had claimed they didn’t have to disclose to the court when they had bought their Northwest shares and how much they paid for them.

Their reasoning: The information would show other investors how the funds worked, letting them horn in on fund strategy and siphoning off some of the profit. Gropper told them they had to comply with standard disclosure rules like everyone else in the case. The funds have appealed his decision.

Gropper’s stand on disclosure is especially welcome at a time when U.S. companies and even Treasury Secretary Henry Paulson are complaining about the costs of telling investors what they need to know. The price is so onerous, they say, corporations may start trading their shares on overseas markets where restrictions are fewer.

By ruling against the hedge funds — which make bets on any variety of investments and take big fees when they guess right – – Gropper exposed their arrogance.

Do the funds really think nobody knows what they’re doing? I suppose they also want us to believe that news of takeovers doesn’t leak from Wall Street before the deals are announced….

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