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Hedge Fund Collusion to Pound Euro?

Posted by Larry Doyle on March 3, 2010 12:35 PM |

Meeting industry friends and colleagues for dinner, drinks, and market talk is standard fare. In fact, I would say it is good business as it is important to develop relationships within the industry.

That said, the development of these professional relationships and the interaction amongst the professionals should never come at the expense of professional ethics and integrity. I did witness more than a handful of times individuals from different shops on both the buy-side and the sell-side of the industry push the envelope very close and sometimes over that ethical line.

Not always, but very often, the ethical shortcomings involved hedge funds. Why? The revenue model for hedge funds (typically 2% asset management fee and 20% of profits derived) serves as a huge incentive for traders at hedge funds to gain an edge and act upon it as much as possible. The fact that the hedge fund traders and managers have a direct stake and an accompanying vested interest in the profits fuels this crowd like nothing else.

What is the result? Very often, the improprieties on Wall Street are centered within the hedge fund community.

Are regulators able to properly monitor and oversee trading activities within hedge funds? Not as easily as some would hope. The Wall Street Journal highlights a current investigation of trading in the euro by hedge funds and reports, U.S. Probes Bearish Euro Bets:

The Justice Department has launched an investigation into whether hedge funds might have banded together to drive down the value of the euro, people familiar with the matter say.

In a letter last week, the department has asked hedge funds including SAC Capital Advisors LP, Greenlight Capital Inc., Soros Fund Management LLC and Paulson & Co. to retain trading records and emails relating to the euro, say people who have seen the letter.

The letter was dated Feb. 26, the same day a page-one article in The Wall Street Journal outlined a large bet being made in recent weeks by heavyweight hedge funds against the euro, in moves that are reminiscent of the trading action at the height of the financial crisis like bets against Lehman Brothers and other troubled firms.

The Journal article disclosed that the big euro bets were emerging amid gatherings including an “idea dinner” involving a number of hedge funds including SAC, Greenlight and Soros, where a trader argued that the euro is likely to fall to “parity,” or equal to, against the dollar on an exchange basis. The euro currently trades at $1.3609.

One of the questions investigators are likely to examine is whether such information-sharing constitutes collusion, the people say. Charges relating to collusion on Wall Street have been a rarity because of the difficulty of proving that firms intentionally sought to act together and acted nefariously.

Have hedge funds colluded to drive down the euro? I do not know. Do people on Wall Street talk and share info? All the time. Is this necessarily collusive? No. Can it be collusive? Most certainly.

How do insiders cover their tracks? They never use real names in discussing their activity or the activity of others.

The aliases can be somewhat comical, but the activity is anything but.

How can regulators level the playing field? How can regulators quickly and immediately address the lack of transparency? Implement the use of the Trade Reporting and Compliance Engine (TRACE) across all product lines. This system requires the timely reporting of a transaction within 15 minutes of execution.

The transparency has a funny way of making the field very level, very quickly.

Wall Street really does not like the TRACE system because it narrows profit margins. Wall Street should be more interested in how it interacts with the investing public and then perhaps they could be less concerned with TRACE and profit margins.


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