7 Ways Hedge Funds Lie, Cheat and Steal
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7. Setting up bets that can't fail:
I’m ashamed to admit it, but this is my favorite. I just can’t get enough of how banks and hedge funds collude to rig securities so that they are designed to fail. The best part is that in order to win their negative bets, they have to market the securities to chumps as if they were pure gold.
This ploy always seems to involve a big investment bank and a hedge fund. You have Goldman Sach’s dancing with Paulson and Company, and then there’s JP Morgan Chase doing a two-step with Megatar.
And what a dance it was. The hedge fund picks the mortgage pools that go into the security so that it will fail, and then bets against it. JP Morgan and Goldman Sachs then sell the crap to investors that trust the banks, which say it’s a good bet, but don’t tell them that the hedge funds were integrally involved in picking the garbage, or that they were betting it would fail. The legalities are tricky. The law seems to come down hard on those who sold the crap but didn’t fully disclose the critical information. That cost Goldman Sachs $550 million (but the hedge fund was allowed to keep its billion dollar profits). At this time, JP Morgan Chase is trying to negotiate a similar settlement with the SEC. But the hedge funds who made many billions on these bets have dodged any penalties. At the moment, there's no law against encouraging someone else to rig a bet for you -- except at the racetrack.
Just a Few Bad Apples?
As Neil Weinberg and Bernard Condon wrote in Forbes back in 2004:
Hedge funds exist in a lawless and risky realm, exempt from the rules governing mutual funds, equities and most other investments. Hedge funds aren't even required to keep audited books--and many don't. These risky funds often are guilty of inadequate disclosure of costs, overvaluation of holdings to goose reported performance and manager pay, and cozy ties between funds and brokers that often shortchange investors.
Even Société Générale, the French megabank (which no one would confuse with Mother Teresa) doesn’t trust hedge funds. Because it deals with hundreds of them and because cheating is so endemic, it has decided to use a computer program to help it identify the ones most likely to cheat.
Of course, none of this proves that any given hedge fund billionaire is a cheat or even ethically challenged. But it does offer an unflattering picture of an industry that at this very moment is trying mightily to avoid any and all new regulations or taxes that might stand in the way of its billions.
It’s not enough to get tougher sheriffs to stop the cheating. We’ll need to wipe out the entire casino if we want to get out of Dodge alive.
Les Leopold is the executive director of the Labor Institute and Public Health Institute in New York, and author of The Looting of America: How Wall Street's Game of Fantasy Finance Destroyed Our Jobs, Pensions, and Prosperity—and What We Can Do About It (Chelsea Green, 2009).