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U.S. House of Representatives,
Subcommittee on Capital Markets, Securities and Government Sponsored Enterprises,
Committee on Banking and Financial Services,
Washington, DC.

    The subcommittee met, pursuant to call, at 10:15 a.m., in room 2128, Rayburn House Office Building, Hon. Richard H. Baker, [chairman of the subcommittee], presiding.

    Present: Chairman Baker; Representatives Lucas, Manzullo, Ryan, Biggert, Terry, Toomey, Roukema, Royce, Paul, Riley, Kanjorski, Bentsen, Weygand, C. Maloney of New York, J. Maloney of Connecticut, Hooley, Jones of Ohio, Capuano and Mascara.

    Chairman BAKER. I would like to call this hearing of the Subcommittee on Capital Markets to order. This morning we will proceed in two steps. The first would be to receive the remarks of one witness with regard to the effects of H.R. 2924, the Hedge Fund Disclosure Act. Upon conclusion of that testimony, the subcommittee will then proceed to markup and will dispose of any amendments which might be pending at that time before moving to final passage of the measure.

    Hedge funds are essentially unregulated mutual funds. They invest money for wealthy individuals and financial institutions seeking high returns or diversification of portfolio risk. Since small public investors are not involved, the kind of Government oversight that protects investors in other forms of collective investment has been historically considered unnecessary.
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    Because hedge fund investors are presumed to be capable of judging risk and bearing the losses that follow from a bad mistake, the failure of hedge funds has not been a public policy concern. An exception to this rule was the Long-Term Capital Management hedge fund which, in 1998, was saved from collapse by the intervention of the Federal Reserve of New York.

    The size of LTCM's market position and the scope of its losses created potentially systemic risk in the Federal Reserve's estimation. That is, if LTCM had been permitted to fail, a number of other major financial institutions would have been exposed to significant loss. The LTCM case revealed a blind spot in current financial regulation.

    How is it possible a single fund, subject to no substantive prudential or disclosure requirements, became so large that its market losses threatened the entire financial network?

    The President's Working Group on Financial Markets in April of 1999 published a report identifying excessive leverage as one of the underlying problems.

    The Working Group has recommended that hedge funds and certain of their creditors be required to make public basic financial information about the size and risk of their portfolios. The essence of H.R. 2924 is a quarterly disclosure that would apply to the largest hedge funds. Section 2 of H.R. 2924 contains a finding that market forces are the best protection against possible systemic risk caused by hedge fund losses, but that such forces do require a minimum of reliable information on which to base their judgments.

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    The hedge funds that would be subject to these disclosure rules are those that are defined in section 3 as unregulated hedge funds. They are basically pooled investment vehicles with a net asset value of $1 billion or more that are professionally managed and not available to the general public and not regulated as public mutual funds under the Investment Company Act of 1940.

    The vast majority of hedge funds would not be affected by the enactment of H.R. 2924; however, there is very little chance that the failure of one of the smaller hedge funds would have potential systemic impact.

    The few large funds that would be covered, and by our most recent estimate, about 25 of those that are covered by the disclosure requirement, are the ones whose failure could move markets.

    H.R. 2924 also addresses the suppliers of leverage to hedge funds and other highly leveraged institutions which may include commercial banks and securities firms. Section 6 expresses the sense of Congress that public companies should include in their financial statement a summary of their direct material exposure to highly leveraged institutions.

    A financial entity, of whatever nature, that can grow to a size where it becomes critical to the orderly functioning of markets? Isn't some form of supervision in this instance not only warranted, but desirable? Banks and securities firms are subject to various degrees of capital adequacy and prudential regulations. Hedge funds are not.

    There are two ways to limit the size of speculative positions, by direct regulation, by limiting capital reserve requirements such as those that apply to banks and securities brokers, or indirectly by reinforcing market mechanisms that ought to constrain excessive leverage. H.R. 2924 takes the second approach.
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    Other things being equal, the larger the individual failure, the greater potential for systemic risk. If large hedge funds are required to disclose size, composition and riskiness of portfolios, suppliers of capital should avoid these funds that take unwarranted risk.

    Whether these requirements would have prevented LTCM becoming excessively leveraged is very difficult to say. In the aftermath of the Fed's intervention, it appeared that banks and brokers had competed financially to do business with LTCM and that normal risk evaluation processes had been abandoned.

    This kind of behavior led the Working Group to observe that if one looks at the history of financial markets, it is true that market-based constraints can break down from good times as creditors become less concerned about risk and fail to manage the risk appropriately. In the case of LTCM, market discipline seems to have largely broken down.

    The Working Group's report called for the consideration of direct regulation of hedge funds only if it appeared the disclosure and other forms of indirect regulation had failed to constrain the degree of leverage. The report was clear in its conclusion that market-based disclosure and regulation of excessive leverage, even with its limitations, is preferable to direct regulation. This is the approach suggested by H.R. 2924.

    Mr. Kanjorski, would you have an opening statement?

    Mr. KANJORSKI. Thank you. Mr. Chairman, thank you very much for giving me the opportunity to speak briefly on H.R. 2924, the Hedge Fund Disclosure Act, the subject of today's hearing and markup in our subcommittee.
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    Let me begin my remarks by commending the Chairman for his leadership on this issue.

    Last year, our subcommittee held hearings in March, May, and June on the role of hedge funds in our Nation's financial system. At the second hearing, we heard from representatives of the President's Working Group on financial markets about the lessons of Long-Term Capital Management. Their report outlined a number of recommendations aimed at abating the possibility of similar situations in the future.

    Chairman Baker carefully listened to the testimony delivered by the President's Working Group that day, subsequently reviewed the report, and in the following months worked to draft the Hedge Fund Disclosure Act.

    Last September, I joined Chairman Baker, along with Chairman Leach, Ranking Member LaFalce, and several other Members in introducing H.R. 2924, a bill to require the largest unregulated hedge funds to disclose quarterly, the size and riskiness of their portfolios. Today's hearing and markup furthers the legislative process.

    From my perspective, the near collapse of Long-Term Capital Management highlighted the possibility that difficulties at one financial institution could affect others and potentially pose systemic risk to our entire financial system. That is, if we had allowed Long-Term Capital Management to fail, a number of other financial institutions might have also failed and markets might have panicked, causing serious losses to many not directly involved in these activities.
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    The President's Working Group identified excessive leverage as Long-Term Capital Management's underlying problem. Our economic system depends on market discipline to constrain leverage. But at times, market discipline can break down. Although we cannot guarantee against future collapses of hedge funds, we should work to ensure that such failures do not significantly damage our Nation's financial system, hamper our economy, or burden our Government. This legislation furthers these public policy goals.

    Instead of directly regulating hedge funds, H.R. 2924 takes an indirect approach of reinforcing the market mechanisms that ought to constrain excessive leverage and speculation in the absence of regulation. In other words, improving transparency through enhanced disclosure to the public should help market participants make better, more informed judgments about market integrity and creditworthiness of borrowers and counterparties.

    In closing, I look forward to hearing today from Lee Sachs, Assistant Secretary for Financial Markets at the Treasury Department, who is representing the views of the President's Working Group. It has already been eighteen months since the Long-Term Capital Management bailout occurred. As time passes, the lessons of this event will certainly fade in the marketplace, and the need for legislative action may also wane. I hope, therefore, that we can move forward quickly to enact this bill to improve transparency, better market discipline, and protect the safety and soundness of the U.S. financial system.

    Chairman BAKER. Thank you, Mr. Kanjorski. I want to thank you and Mr. LaFalce for your cooperative work in this matter and certainly appreciate your cosponsorship of the resolution.
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    Are there other Members with opening statements?

    Mr. Toomey.

    Mr. TOOMEY. Thank you, Mr. Chairman. And I want to begin by commending the Chairman for the diligent efforts that he has put into addressing the concerns articulated by the President's Working Group and coming up with a proposal that at least certainly avoids a heavy-handed direct regulatory burden on this industry.

    I think the requirement of disclosure sounds rather innocuous on the surface, but, reluctantly, I will be opposing this legislation, because I think, to a certain degree, it is a solution in search of a problem. It is not clear to me that this legislation is necessary. I am concerned that it could put an onerous burden on an industry and could, in fact, put American financial institutions at a competitive disadvantage relative to competitors from Europe and Asia in particular.

    I think the premise of the legislation is, in fact, that the markets do not work in the sense that markets and sophisticated investors are not capable of determining what information they need adequately to assess the risk they choose to take. Therefore, there is the need for the Government to impose this disclosure.

    In addition, there is no question that this bill is a response to the Long-Term Capital Management situation, and I for one believe that the risks to the entire financial system posed by that situation have been frequently exaggerated.
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    I think it is important to bear in mind what hedge funds are all about. Many hedge funds exist, and their entire stock in trade is their ability to pursue and exploit very sophisticated strategies of finding market inefficiencies. They do this with folks that are trained in very sophisticated analysis. In some ways, it is inherently a proprietary business.

    I would cite an analogy that, while flawed, it might be worth thinking about. Requiring hedge funds to disclose the risks that they are taking reveals the nature of their business strategy in a way that will be comparable to requiring Mrs. Field to reveal the recipe and the baking instructions of her cookies. It is inherent to the product that they have. And forcing revelation of that, I think, puts these firms at a competitive disadvantage.

    I think the fact is that the markets do work and the market forces are the best tools for constraining excessive leverage and that the highly sophisticated institutions that are involved in this are quite capable of defining and receiving the information that they need.

    I would also point out that a number of new protections have already been put in place. Certainly, the institutions that extend credit to hedge funds, as a matter of the course of their business, have already implemented extensive and rigorous new forms of analysis in their credit departments which I have heard a great deal about in discussions with some of them. In addition, the regulators themselves have responded by focusing on beefing up firms' ability to measure risks.

    As I said earlier, I think that this approach will be detrimental to American financial institutions, in part by encouraging hedge fund activity to just take place offshore, beyond the reach of American regulators.
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    And I think, perhaps to a lesser extent, there is a question about whether this legislation imposes a moral hazard problem in the sense that we might be creating the illusion that the Federal regulation exists where, in fact, there wouldn't be any meaningful Federal regulation, and giving the signal, perhaps, that some of these hedge funds might be ''too big to fail,'' which I think arguably is a signal that the Fed has already sent in its experience with Long-Term Capital Management.

    So it might be possible to amend this legislation and improve it in ways; however, frankly, we are not going to really have time to reflect on the testimony we are about to hear, nor, unfortunately, are we going to get testimony from folks who are opposed to this legislation.

    So I will not be offering amendments today. But I would consider doing that at some point in the future when we go on to full committee markups. Thank you, Mr. Chairman. I look forward to questioning the witness.

    Chairman BAKER. I thank you, Mr. Toomey.

    Mrs. Maloney.

    Mrs. MALONEY. Thank you, Mr. Chairman, and thank you for your leadership on this issue.

    The Capital Markets Subcommittee is convened today considering the issue of hedge fund disclosure for two reasons. The first is the spectacular near failure of a high-flying reckless hedge fund that, according to the Federal Reserve, came close to causing a serious disruption in world financial markets that could have had widespread effects.
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    At the same time, we must consider the precedent set by the Federal Reserve in invoking its authority as the U.S. Central Bank to engineer a bailout for a private fund where the investors were never given any guarantees by the Government.

    With regard to the actions of the Federal Reserve to arrange a bailout to save Long-Term Capital, I believe the Baker bill which follows the recommendations of the President's Working Group takes a step in the right direction by increasing disclosure.

    At its introduction, I declined to co-sponsor his bill because I thought that the funds that would be covered were set so high as to be inconsequential. I am pleased to see that the manager's amendment adjusts the reporting requirements to apply to funds with $1 billion of net asset value or $3 billion in total assets. I still have reservations about how the disclosure itself will be reported.

    Under the bill, the Federal Reserve will act as a pass-through that will make the disclosures available to the public so that investors can make more informed decisions as to whether they want to do business with a particular fund.

    While the Fed insists that it is not regulating hedge funds, I believe this involvement by the Fed may send the wrong message to the markets, given the precedent that it set in managing the bailout of LTCM.

    At the same time, I understand that the job of making hedge fund disclosures public must be handled by some regulator. Because of the unprecedented action by the Fed, we must make perfectly clear to the public that these disclosures are being handled by a passive regulator that is not actively involved in overseeing hedge funds.
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    I look forward to the markup and sending the bill to full committee. Thank you.

    Chairman BAKER. Thank you, Mrs. Maloney.

    Mrs. Roukema.

    Mrs. ROUKEMA. Yes. Mr. Chairman, thank you. And I will just include my whole statement for the record. But I do want to commend you certainly for your leadership here. And I am very pleased to be a co-sponsor of this legislation.

    As you and others have noted, the lesson of Long-Term Capital Management should not be lost on us. That is the reason, one of the prime reasons—knowing that is one of the prime reasons why we are taking this action here today.

    I should certainly say and want to repeat, and I think it bears repeating over and over again, the question is systemic risk. We need to identify those hedge funds which could pose a systemic risk to the system as we saw illustrated in the handling of Long-Term Capital Management.

    I won't go into detail about this, but I do note that I think that the Fed took the proper action. There have been some here that have questioned that action. But I believe that they took the proper action. But it also points out the need for this legislation.

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    I would certainly say that there are questions as to the size of the funds which will be covered. I do understand that the manager's amendment, which lowers the threshold at which a fund is covered, will be coming up. I think, in all respects, you have put the proper balance here in terms of both the size and the way the information is handled by the Federal regulators.

    The point that I would like to make strongly here, and I don't know that anyone else has made this point, that we shouldn't legislate lots of unnecessary reporting and regulations for the hedge funds, because most hedge funds do not pose a systemic risk. Regulations for regulations' sake is not a virtue.

    That having been said, Mr. Chairman, I believe that you have taken the right approach here. I'll admit that we may need to look at changes to the manager's amendment. I think it is quite well thought out, however, if I understand the manager's amendment. I firmly believe that you have struck the right kind of balance between regulation and the size and our valid concerns for systemic risk. We don't want hedge funds posing a threat to safety and soundness of the financial system. Thank you, Mr. Chairman.

    Chairman BAKER. Thank you, Mrs. Roukema, for your courtesies and assistance in this matter.

    Mrs. Jones.

    Mrs. JONES. Good morning, Mr. Chairman, Ranking Member Kanjorski, and Members of the subcommittee. I want to thank you for bringing this issue to the subcommittee.
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    The Hedge Fund Disclosure Act is another effort to bring better stability and viability to our financial market. It provides a system by which information is disseminated relative to the total assets of the fund, total derivatives position, balance sheet leverage ratios and other information the Federal Reserve may deem necessary.

    With hedge funds investors using investment funds of Americans, it is important to set up protection gauge for the large funds that have the potential to disrupt markets if a fund fails or losses are too great. We do have a role as a subcommittee to move legislation that serves to aid in our financial market and provide for greater information and leverage as well as having additional eyes looking at the larger hedge funds.

    I am pleased to know this subcommittee has taken a positive stand. Thank you very much, Mr. Chairman.

    Chairman BAKER. Thank you, Mrs. Jones.

    Yes, sir, Mr. Manzullo.

    Mr. MANZULLO. I appreciate the opportunity to be here this morning. I have some concerns. I was practicing law when RESPA was adopted, I think by this subcommittee. That was supposed to be just disclosure, now it is a nightmare. You read how the Department of Education started. There is a statement by Patsy Schroeder commending the author of the legislation that the number of employees of the Department of Education was set by statute not to exceed 50. It is now 5,500.
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    I think what is bothersome to me about the legislation, if you look at the section-by-section analysis, section 2, findings, number 7, it says, ''The U.S. Government must insure that the failure of one or more hedge funds never cause a severe burden on the U.S. financial system or the U.S. payment system and that Federal resources are not squandered in efforts to salvage collapsed hedge funds.''

    Ostensibly, the preamble to the legislation uses the word insurance, uses the word failure; and yet this language, the proposed language is in terms of disclosure and not in terms of regulation. It ostensibly says that the purpose of it is to insure; and yet we see no regulation, although I am not in favor of it, and we see no premiums being paid, not that I am in favor of that either. So I have a problem with really even the preamble saying the purpose of this legislation.

    I would think that, ultimately, if a firm invests in a hedge fund, and it is a poor decision, and the poor decision is based not upon the market, but based upon an analysis, then that house or bank or whatever institution is ultimately liable to its shareholders by way of breach of fiduciary duty as opposed to this bill, which to me, if it is passed, calling for these minimalist disclosures, will allow the companies that make the investments to rely upon the disclosure as meeting some type of a prudent man's standard, thereby alleviating what could have been—or could not have been any type of a derivative action based upon breach of fiduciary duty.

    I don't like regulations. If people want to take the risk, that is fine. But I believe that the people who take the risk owe the responsibility of investigating where their money goes, and that there should be no particular type of regulation here.
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    If the disclosure is required, then I think that will lead to regulation down the line, and that will simply end up in pushing these houses offshore, which could really be disastrous for American investments.

    Chairman BAKER. Thank you, Mr. Manzullo.

    Any further Member?

    Mr. Ryan.

    Mr. RYAN. Thank you, Mr. Chairman. I look forward to hearing the testimony from the witness this afternoon.

    I, too, have some concerns. I guess the question is we are here to make sure that we don't risk the credit and contingent liability of the American taxpayer. The question is, by requiring this new disclosure, does that prevent that risk in the future, or does that encourage that risk in the future?

    I just have concerns about the slope we are going on. Will this end here, or will this go down the road of direct regulation, which could give us more of a contingent liability from the taxpayers that we are here representing?

    I think this could be setting up a dangerous precedent. I look forward to hearing the rationale from the witness this afternoon. But I have a concern that requiring regulators to collect these kinds of reports may create the illusion of regulation where none exists, thereby creating moral hazard.
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    I think these are important questions for us to answer, and I don't know the answer to these questions. But I look forward to hearing from the witness.

    Chairman BAKER. Thank you, Mr. Ryan.

    Any further comment? I would like to add for the record that, whether a wealthy person makes or loses money is of no consequence to me or this legislation, and whether a hedge fund stays solvent or not is of no consequence to me and this legislation.

    What is of extreme consequence is whether or not my parents' pension fund remains solvent, because LTCM fails and takes significant assets of their retirement when they have no direct knowledge of, participation in, or awareness of funds like LTCM.

    For those reasons, I hope Members will carefully consider implications of not acting favorably on this legislation.

    I would like to welcome this morning the Under Secretary for Financial Institutions; is that correct?

    Mr. SACHS. Assistant Secretary for Financial Markets.

    Chairman BAKER. Financial Markets. Excuse me, Mr. Sachs. To represent here today not only his own perspective, but, as I understand it, to speak on behalf of the President's Working Group which had in its structure representatives of the Fed, the Treasury, the FTC, and CFTC, who spent considerable time analyzing the aftermath of the LTC problems and came forward with a report on which the legislation is based. You are certainly welcome. I appreciate your fine work.
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    Mr. SACHS. Thank you, Mr. Chairman, and Mr. Kanjorski, and Members of this subcommittee. I appreciate the opportunity to appear before you today on behalf of the President's Working Group. I also thank you for the leadership you have demonstrated on this important matter.

    Today I would like to focus my comments on two broad areas. First, I will briefly address the developments in systemic risk mitigation since the Working Group issued its report on hedge funds in April of last year.

    Second, I will focus on the importance of market discipline and enhanced transparency and disclosure and the ways in which H.R. 2924, the bill you will be discussing later today, introduced by yourself, Mr. Chairman, and Ranking Member Kanjorski, and other Members of this subcommittee, how that would help to promote enhanced transparency in our financial system.

    As you recall, in the immediate aftermath of the near collapse of LTCM in September of 1998, then-Secretary Rubin called on the Working Group to prepare a study of the potential implications of the operations of firms such as LTCM. The Working Group report concluded that the near collapse of this fund highlighted the possibility that problems at one financial institution, whether that institution is a hedge fund or other highly leveraged institution, could be transmitted to other institutions and potentially pose risks to the financial system. That excessive leverage in such institutions can increase the likelihood of a general breakdown in the functioning of financial markets. Thus, the principal public policy issue arising out of the events surrounding the near collapse of LTCM was how to constrain excessive leverage more effectively.
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    To this end, the Working Group set forth a series of recommendations designed to help constrain excessive leverage and thereby help to reduce the likelihood that future failures of individual institutions could pose a threat to our financial markets more broadly.

    Three broad themes united these recommendations. The first is that our market economy relies primarily on market discipline to constrain excesses, particularly excessive leverage. The second is that market discipline must be built upon sound risk-management practices by all market participants. And, third, in order for markets generally to impose that discipline, there must be sufficient transparency and information available to allow individual participants, including creditors, counterparties, and investors, to make more informed investment and credit decisions.

    Let me very briefly update you on the progress that has been made to date on the implementation of the recommendations from the report that promote these themes.

    First, our call for regulators to encourage improvements in the risk management systems of regulated entities was answered last year when the Federal Reserve Board and the Office of the Comptroller of the Currency issued new guidelines urging improvements in such systems.

    Second, the provisions recommended by the Working Group to improve the netting regime for certain financial contracts in bankruptcy and bank insolvency situations are currently a subject for the conference committee on the bankruptcy bill, and we urge Congress to adopt these financial contract netting provisions.
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    Third, the private sector has responded to the Working Group's calls for improvements in their risk management practices with groups such as the Counterparty Risk Management Policy Group and a group of the largest hedge funds publishing reports outlining detailed recommendations for improved risk management standards.

    Fourth, on the international front, groups such as the Highly Leveraged Institutions Working Group of the Financial Stability Forum are taking a hard look at highly leveraged institutions and their effect upon world markets. The HLI Working Group report will be released in a few weeks, and we expect it to broadly support the thrust of the proposals of the President's Working Group, including the legislation being discussed today.

    Let me now turn to H.R. 2924 and the issues of market discipline, transparency, and disclosure. The premise of the Working Group's recommendations is that, in our market economy, the primary mechanism that should and does regulate risk taking is the market discipline provided by market participants. This discipline can serve to constrain excessive leverage and thereby reduce the associated risks. But its effectiveness is contingent upon counterparties and investors having the information necessary to impose such discipline. The Government cannot impose market discipline, but can help to enhance the effectiveness of that discipline by creating an environment of greater transparency.

    Indeed, the long history of public disclosure and transparency in our financial markets has been a source of great strength and a leading factor in establishing and maintaining the high degree of confidence the world has in the integrity of U.S. financial markets. This confidence, in turn, increases investment in our markets, lowering the cost of capital for American businesses and individuals, and thereby helping to strengthen the U.S. economy.
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    Several of the Working Group's recommendations were designed to enhance transparency, and important efforts are already under way to enact some of these.

    First, the CFTC has been drafting proposed regulations that would require more relevant and more frequent information from large commodity pool operators regarding the funds they operate and would make this information available to the public. These regulations will be similar to the provisions contained in H.R. 2924.

    Second, the SEC has been studying ways to implement the disclosure recommendation for public companies and has indicated that they will introduce a draft for public comment in the near future.

    H.R. 2924 would contribute to these efforts to enhance transparency by implementing the Working Group's recommendations regarding public disclosure of more frequent and meaningful information on the largest hedge funds.

    If the manager's amendment is adopted, the bill would require that only the largest unregulated hedge funds provide basic non-proprietary financial information and meaningful and comprehensive measures of risk to the Federal Reserve Board of Governors. The Federal Reserve would then share that information with other members of the President's Working Group and disclose the information publicly, allowing market participants to make more informed investment decisions.

    One of the primary areas of concern expressed by the private sector has been the challenge of balancing the disclosure necessary to enhance market discipline with the need for protection of proprietary information essential to the firms' ability to engage in business transactions.
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    The Working Group is sensitive to this concern. We believe that this bill, with the manager's amendment, strikes the appropriate balance by providing the Federal Reserve with the flexibility to determine what information is both relevant and useful without compromising the firms' ability to engage in business transactions.

    This bill does not call for direct regulation of hedge funds. It is our view that investors in hedge funds are generally high net worth individuals or institutional investors, and the usual investor protection grounds for such regulation are not necessary.

    Moreover, a direct regulatory regime could create a form of moral hazard in which market participants, knowing that a highly leveraged institution is regulated and supervised for systemic reasons, might reduce their normal due diligence and relax their risk management standards. Thus, rather than imposing direct legislation, H.R. 2924 would provide for enhanced public disclosure only by those hedge funds that are large enough such that, if any one of them were to fail, such failure could potentially pose risk to the financial system more broadly.

    We recognize that enhancing transparency and disclosure and providing information to market participants does not guarantee that those participants will process or use the information effectively. However, it is equally true that if the information is not made available, it cannot be processed or used at all. Thus, the Working Group is seeking to provide the market with one of the key ingredients to making informed credit and investment decisions and thereby collectively promoting greater market discipline.

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    In this way, this bill, combined with the Working Group's other recommendations would take an important step in helping to mitigate systemic risk.

    Finally, I would like to thank you, Mr. Chairman, Mr. Kanjorski, and other Members of the subcommittee for the spirit of cooperation with which you have approached this bill. We are pleased with the results of this cooperation and the steps this bill as amended takes in promoting our efforts to create an environment conducive to enhanced market discipline.

    I will now be happy to take any questions. Thank you.

    Chairman BAKER. Thank you very much, Mr. Sachs. In your prior professional career, you engaged in market activities, as I understand it; is that correct?

    Mr. SACHS. Yes, sir.

    Chairman BAKER. In what capacity?

    Mr. SACHS. I was at an investment bank for thirteen years, and I was head of Global Capital Markets.

    Chairman BAKER. In your professional opinion, if the requirements of H.R. 2924 were put in place today, would that significantly impact a hedge fund's method of operation or cause them to evaluate whether they should relocate?

    Mr. SACHS. It is my judgment that that would not cause them to reevalute where they should locate. Many hedge funds today, the great majority, currently file the same information that is contemplated in this bill with the CFTC by virtue of being commodity pool operators.
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    Importantly, the approach that you have taken with this bill states very clearly that proprietary information, information about specific positions and types of investments, will not be disclosed to the public. That would be a very different situation and is not something that any member of the Working Group would be recommending, nor is it contemplated in this bill.

    Chairman BAKER. With regard to commodity pool operators, I think I need to emphasize the point you made where the CFTC, SEC will be promulgating regulations that would require those regulated operators to disclose the elements contained in this legislation, and that regulatory action is expected to take place in the near term; is that correct?

    Mr. SACHS. Yes. In the near term. They have circulated a draft, the CFTC has circulated a draft among other members of the Working Group. We anticipate the CFTC will be in a position to release that soon. As you have been discussing this bill over the recent past, we have also been coordinating with each other and with the CFTC to ensure that similar information would be involved with both hedge funds that report and disclose information through the Federal Reserve Board and those that would be reporting and disclosing through the CFTC.

    Chairman BAKER. So if the CFTC proceeds to act and H.R. 2924 is finally adopted, every participant in the market would be treated in the same fashion; is that basically correct?

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    Mr. SACHS. I think that is correct, yes.

    Chairman BAKER. And that would basically constitute quarterly reporting of the required information which is not proprietary.

    Mr. SACHS. Correct.

    Chairman BAKER. The only concern I have from the bill as introduced to the construction of the manager's amendment—and for the Members of the subcommittee, the manager's amendment reflects agreements reached with myself, Mr. Kanjorski, and the regulators about the scope of who would be required to report. As originally drafted, the bill would have applied to approximately 15 to 18 firms. As amended by the manager's amendment, that number might grow to 25, ball park. Is that about correct?

    Mr. SACHS. Yes, that is our estimate based on information that we have been able to obtain from various sources. It is hard to come up with an exact number, because many of these funds don't file with anyone at this time. So there is no way to have an exact figure. But our estimation, yes, it would be about 25.

    Chairman BAKER. It would be my hope that, between action of the subcommittee today, and if we do get to floor consideration or full committee, that the Working Group would continue to assess the regulatory scope of the new definition so that we might accurately determine who really is covered.

    I understand there are about 3,000 hedge funds, and so a very small percentage of firms actually would come under the scope. And, again, to make the point, it is because of your net asset value being extremely large, and, second, because of the degree of leverage, and because of those characteristics, then the reporting requirement would become effective. And that is why it is a little difficult to know today exactly how many funds would be covered, because we don't have that information.
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    Mr. SACHS. Yes. That is correct, Mr. Chairman. I would also just state, as you have pointed out correctly, it is our estimation that less than 1 percent of all hedge funds out there would be covered by this bill. And the reason that it is only or less than 1 percent is the intention of the Working Group's recommendation, and I believe the intention of this bill when you proposed it, was that only those hedge funds that are large enough such that if they were to fail could potentially pose risk to the system.

    We believe that it is appropriate for that information to be available to the public more broadly so that the markets can impose the necessary discipline as we discussed earlier. We did not feel that it was important or desirable to have funds that fall below this level covered by the bill.

    Chairman BAKER. Thank you, Mr. Sachs.

    Mr. Kanjorski.

    Mr. KANJORSKI. Mr. Secretary, in your estimation, if this bill had been passed five years ago and was signed into law, what kind of effect would it have had on the situation of Long-Term Capital Management?

    Mr. SACHS. If this bill were in place five years ago, the information about how large and how leveraged Long-Term Capital was at the time would have been public. Investors would have had the information to make rational or to make at least informed credit and investment decisions.
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    It is our feeling that if the information were available and those decisions were made with the appropriate information, that perhaps that would have enhanced market discipline and exerted constraints on the size and the leverage of that fund.

    We can never be certain as to what would have happened; but, in general, we feel quite strongly that greater transparency will allow those market forces to work more effectively. I can't say for certain that it would have prevented that situation, but it would decrease the likelihood that situations like that could evolve in the future.

    Mr. KANJORSKI. We reached an agreement between the committee, the Administration and the Working Group to reduce the bill's thresholds to $1 billion capital and $3 billion in total assets. Do you feel that there is a possibility that, to avoid transparency, these funds can be parceled out into smaller cooperative funds? That is, could they be individually of that size so that they could still have the same financial impact on the market, but not have to have the transparency that we are attempting to accomplish with the passage of this bill?

    Mr. SACHS. I would say a couple of things, Congressman. Number one, the way this bill is drafted, any fund or family of funds that met this threshold would be covered by the bill. And, second, it would be for someone to set up separate entities and have them controlled by different individuals would, perhaps, be much more of a burden than having to file the information that they already have available to them with the Federal Reserve Board.

    Mr. KANJORSKI. Now, we have two instances of Members indicating some of their hesitancies or concerns about this bill. Some feel that we are on a slippery slope. That is, by virtue of having disclosure, we are really taking the first step toward regulation. If you could, please respond to that argument.
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    And, second, so that it is very clear as a matter of the record: there is no intention of the Administration, the Working Group, or this subcommittee to implicitly guarantee that the Government as a matter of public policy intends to bail out hedge funds in the future. Is that correct?

    Mr. SACHS. Yes. I can address both of those questions. As far as the slippery slope goes, clearly that would be up to this subcommittee and others in Congress as to whether any further steps would be taken. We feel quite strongly that it is not necessary or desirable to take further steps. At this time, we have seen no evidence that that would be necessary. I do not believe that any member of the Working Group would be advocating that we go further than this bill does at this time.

    As far as the guarantee or the bailout goes, we do not believe that this bill in any way would imply a guarantee by the Federal Government for any of these institutions. Public companies, whether they are banks, financial institutions, or other companies all file and disclose public information about their financial condition, and that does not necessarily imply that the Government would step in to bail out any of those corporations.

    Mr. KANJORSKI. All right. Finally, if I may just ask one more question, Mr. Chairman. Am I to understand or believe that in the case of Long-Term Capital Management, highly sophisticated investment banks and financial institutions provided literally billions of dollars of investment and credit without having the information that will be set forth in this bill? Or did they have that information and ignore it?

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    Mr. SACHS. Mr. Kanjorski, it is our understanding that there was some of both. We believe that a number of the institutions had the information that was necessary but did not process it appropriately. And there are some that told us that they simply did not—could not get, or did not request, the information that was necessary and, yet, went ahead and made the credit decisions and investments that they did, regardless.

    Mr. KANJORSKI. As this bill is crafted, do you think this is the least interference with the free market that the Congress and the Administration can make?

    Mr. SACHS. We believe this is very much a market-oriented approach. It is—as I indicated earlier, this is the approach that, and as the Chairman indicated before, there were a number of paths down which you could have gone. This is among the most market friendly approaches that one could have taken. This is an effort to assure that market forces, not Government regulation, but market forces impose the discipline on market participants. As I said, in order for markets to do that, it is important that they have the information—that participants have the minimal information that is being contemplated here. So, yes, it is very much a market friendly approach.

    Mr. KANJORSKI. Thank you, Mr. Chairman.

    Chairman BAKER. Other Members with questions?

    Mr. Ryan.

    Mr. RYAN. Mr. Sachs, I just want to follow up with what Mr. Kanjorski was asking. I guess the question we on the subcommittee have to answer is does this bill lead to preventing any bailout in the future, or would it lead to possibly encouraging other bailouts in the future? That is a question I guess we have to answer here.
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    What I want to ask you is, after the Long-Term Capital episode, what happened to the hedge fund industry in terms of transparency and reporting? Was there a degree of self-regulation? Was there a degree of a new sense of transparency in reporting? And if so, has that been continuing on? What happened after the LTCM?

    Mr. SACHS. If I can address your first question first about would this legislation potentially lead to a bailout. We do not view this legislation as adding to that possibility.

    Mr. RYAN. You believe it will help prevent one, right?

    Mr. SACHS. We don't believe this legislation has any implications for whether a fund would be ''bailed out.'' We wouldn't advocate a bailout of a hedge fund whether this legislation were in place or not.

    We do believe that, if this legislation were passed, that it could reduce the likelihood or frequency of failures such as the one that led to the introduction of this proposal. But in terms of whether or not the Government would be involved in bailing out a fund, this legislation doesn't have any implications on that front.

    In terms of what happened post-LTCM, we did see some evidence of a tightening of credit standards between counterparties and the hedge funds. It appears to have acted as a wake-up call that those procedures and policies needed to be tightened up.

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    But, again, as we stated in the hedge fund report we released last year, these kinds of things tend to happen in the immediate aftermath. And then, as prosperity continues and markets remain strong, complacency can at times set in. That is one of the reasons why we think it is important for the markets as a whole, not just individual counterparties and creditors, to have the information that is being discussed in this bill.

    Mr. RYAN. Has that complacency set in, from what you have seen?

    Mr. SACHS. With regard to credit extended to hedge funds, we haven't seen evidence of that yet. But it is hard to say.

    Mr. RYAN. OK. I have one more question. In your testimony, you say, if the manager's amendment is adopted, the bill would require the largest unregulated hedge funds provide basic non-proprietary and financial information and meaningful comprehensive measures of risk to the Fed. And I see that you are extremely sensitive to proprietary information in that, in order to protect that, the Fed has given quite a bit of flexibility in determining that.

    I am just curious, where do you draw the line? In the exercising of your discretion, determining what is proprietary information, what is your understanding of what is proprietary and what is not proprietary at this time?

    Mr. SACHS. First, if I can just state quite clearly that the members of the Working Group have no intention of requiring hedge funds to disclose information that could prevent them from engaging in their business. That is not our intention, nor do we think it would be helpful, and, as I believe Congressman Toomey indicated earlier, could potentially be harmful.
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    What is contemplated in this bill and what we have discussed among the Working Group members is general consolidated summary financial information that would indicate size and overall risk of these funds. That is information that public financial institutions such as banks and broker-dealers currently make public today every quarter by filing with the SEC. And that information is obviously public and does not in any way inhibit them from engaging in their business.

    It does, on the other hand, help by providing transparency and enhancing market discipline. Because if any one of those institutions were to become too heavily leveraged, market forces would raise their cost of capital and would act to constrain those excesses.

    As far as what specific information would be—as far as what information beyond that would be disclosed, I believe that will be up to the Federal Reserve, and they will discuss it with the other members of the Working Group.

    Mr. RYAN. When the Working Group put together their finding that the Fed should have discretion in determining what is and what is not proprietary information, and given the fact that this bill seems to apply to about 25, I think 25 or 27 known hedge funds at this time, did the Working Group contact these hedge funds and ask them, which do you prefer? Do you think a standard set-in-stone transparency disclosure requirement for this set of information would be preferable to added discretion at the Federal Reserve, or do you think that the Fed should have more discretion to, on a daily basis, try to make sure that they police what is believed to be proprietary information? What have the hedge funds themselves said about this?
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    Mr. SACHS. A couple of things. There has been, and certainly will continue to be, an ongoing dialogue between the public sector and the private sector. As I believe I indicated in my opening remarks, the private sector has issued, I believe, three reports at this point which touch on this subject. This dialogue is going to continue.

    One of the reasons we wanted the Fed to have flexibility is that the art and the science of risk management and risk measurement is constantly evolving. Concepts that are available today to measure risk were not applicable—were not even contemplated even five or ten years ago.

    So rather than having to come back and have legislation amended to address that progress, we thought it was more efficient and better for the Fed to have that.

    Mr. RYAN. That seems to make quite a bit of sense. But had you been working with these hedge funds themselves in determining this? And I am just curious what the hedge funds' reactions were to this, meaning you can't freeze the market in place, you can't give us a solid definition on what should and should not be revealed, therefore it should evolve; discretion should occur. Is that what the studies in the hedge funds have been calling for? And if so, are you working on a daily basis or frequent basis in discussing with them what is proprietary and what is not proprietary?

    Mr. SACHS. We have been engaged in dialogue with the private sector, yes, and will continue to be. Again, just at the risk of repeating myself, we believe it is very important that we not constrain these organizations' ability to conduct their business. We believe that hedge funds can add value and do add value to the efficient functioning of our financial markets and do not want to put them in a position where they cannot conduct their business.
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    This is a balance. And it is something that I believe we need to work out among the Working Group members and the private sector.

    Mr. RYAN. OK. I just wanted to get a sense where you are on these things. I see my time is expired. Thank you for your answers.

    Chairman BAKER. It would be my intention to recognize additional Members for questions at this time and briefly recess for the vote on the floor. I wish to advise Members, when we return from the vote, depending on the number of Members asking questions, we would then proceed to markup. I want to make you aware of that so you can make plans to return.

    Mr. Bentsen.

    Mr. BENTSEN. Thank you, Mr. Chairman.

    Mr. Sachs, I am inclined to support this bill. The Chairman is going to be sorry he called on me, but I am inclined to support this bill at this point.

    I do have some questions. And I am a little confused by your testimony in a couple of points, and it may be my own confusion. But when we started down this road after Long-Term Capital Management, it was my understanding that the concern of the regulators and of Congress was not so much market transparency as it was transparency to the regulators. And I read your testimony to indicate that one of the things that the Working Group is looking at and one of the things that you see in this bill is adding more disclosure for market transparency to consumers.
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    Now, I don't want the record to show that I am opposed to disclosure. I very much believe in it. But we are talking about a slightly different animal in terms of hedge funds. These are private transactions among high net worth investors, as opposed to public investments subject to various registration laws under the Securities and Exchange Act.

    And I thought our concern was primarily whether or not financial regulators in this country had sufficient information to determine whether a hedge fund had gotten so large that it could cause systemic consequences throughout the financial markets, as was the case with Long-Term Capital Management, because of positions that they took.

    So I would like you to address that. Because I think when you go a little bit further, you do raise the specter of new regulation on the hedge fund industry, which may require more review by this subcommittee.

    Second of all, I am curious whether or not you believe, or whether your counsel believes, that the disclosure provided for in this bill causes a new standard or creates a new level of liability in the same way that you have liability in public disclosure, whether or not something is material or not. Does that arise here as well?

    In addition, did you tell us—you mentioned a little bit the international aspects. But how does this comport with regulations abroad in Europe primarily and in Asia? Is this something that is in accord with the Basel Accords. And does this new Fed reporting requirement comport with other types of financial market regulations that the Fed currently has authority, or are we creating a new realm of authority within the Federal Reserve?
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    And I am not trying to come at this from a hostile standpoint. I am just trying to get a handle that we are not overreacting here. I think the Chairman has done a good job in taking what the Working Group had originally come out with, which looked to me a lot like public registration of hedge funds and has tempered it down, both he and Mr. Kanjorski. But I want to get your comments on that.

    And, finally, I would like to get your comments, because I don't completely understand from your testimony, does the Treasury Department support this bill? Does the Federal Reserve support this bill? And I know you can't speak for them, but you might know. Does the Securities and Exchange Commission support this bill? And does the CFTC support this bill?

    And, Mr. Chairman, I apologize I probably used up a lot of time asking. We may have to come vote and come back.

    Chairman BAKER. Why don't we go to the five-minute bells, and then we will recess.

    Mr. SACHS. Did you say you want to go to——

    Chairman BAKER. We will have one more set of bells, then we will have to leave at five minutes. But if you want to proceed to begin to answer some of this, maybe you can use the intervening time to think about it, too. If you want to proceed.

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    Mr. SACHS. It's up to you.

    Chairman BAKER. Please proceed, and we will begin with your answer anyway.

    Mr. SACHS. OK. I hope I remembered all the questions.

    First, as far as your opening point about public disclosure versus disclosure to regulators, I believe—or we certainly attempted to be clear in the Working Group report—that this information be made public and shared with the public, in part to avoid any questions about moral hazard.

    More broadly, the concept of transparency, as I indicated in my opening statement, is one of the hallmarks and the great strengths, one of the great strengths of our financial system, and that market discipline itself depends on that transparency.

    As far as——

    Mr. BENTSEN. If I might interject quickly, though, and you know more about this than I do, but if there is a public offering of a security, and a security that trades on the regulated markets, you are subject to quarterly registration and disclosure, and you are subject to obviously the public disclosure at the time that you offer.

    If you have a privately placed security, the disclosure is between the purchaser and the issuer. And in the hedge fund world, if I understand it properly, it is more of a private placement world.
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    And the question I have is, have we crossed the gap here where we are taking a privately placed world and putting it in a publicly disclosed world? Again, I am not trying to be against disclosure, but I am just curious whether we created a hybrid product here or not.

    Mr. SACHS. It is not our intention that we cross that line at all and believe that this bill, as constructed in dealing with or in capturing only the very largest hedge funds, fewer than 1 percent of the total outstanding, it is not intended to cross that line, but rather to assure that the largest hedge funds, only those that, if they were to fail, could potentially pose risks to the system more broadly, that that information is made available to the public.

    Back when the Long-Term Capital episode occurred, many, if not all, market participants were impacted in one way or another, regardless of whether they were creditors or counterparties or investors to or in Long-Term Capital. Because an institution of that size can have that kind of impact more broadly, we believe that that information is important. It is important for market participants to have that information. It is not intended to cross the line that you drew.

    Chairman BAKER. Let me suggest we stop at this point. We are down to right at the five-minute bells. We will stand in recess pending the vote return.

    Mr. SACHS. Yes, sir. I'm sorry, two things if I could. Can I ask my prepared remarks be submitted for the record?
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    Chairman BAKER. Absolutely.

    Mr. SACHS. Congressman Bentsen asked if we supported this bill. And, indeed, this bill implements one of the recommendations that we made in the Working Group report.

    Chairman BAKER. As well as the CFTC. I think that was his other point.

    Mr. SACHS. Yes. When I said ''we,'' I mean all the members of the Working Group.

    Chairman BAKER. I specifically wanted to——

    Mr. BENTSEN. And I will be back. We can talk about the other questions.

    Chairman BAKER. We stand in recess.


    Chairman BAKER. If we can reconvene our hearing, at the time of the recess, Mr. Bentsen had the floor, and the Secretary was responding to his questions.

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    I don't know if Mr. Bentsen wants to restate.

    Mr. BENTSEN. Let me, Mr. Chairman, if I might, for both Mr. Sachs' benefit and my benefit, restate it, a couple of these.

    We have discussed the question of this new standard of disclosure. And I think he can talk a little about whether or not we are creating new liability or any contingent liability for hedge funds with it.

    When we were leaving, he was talking about whether or not—what was the support of the regulators for this bill. If he could go through that, not just Treasury, but if he happens to know about the others that are part of the Working Group. And I appreciate that he can't speak for other agencies necessarily.

    I am eager to know how this compares with hedge fund regulation abroad, what is going on with—you touched on a little bit in your testimony what discussions were going on with international banking, with other financial regulators abroad, whether or not there would be an international standard of some sort, and whether or not, in your opinion, both as a member of the Administration as well as from your own private sector experience, do you think this will have any impact in causing funds to move abroad and outside the scope of this legislation were this legislation to become inactive.

    Mr. SACHS. Thank you, Congressman. Let me try and address these questions one at a time.

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    As far as the last question we left with before the recess, I did have a chance to talk with our counsel about the question of whether or not this legislation would increase liability, a liability for the hedge funds. And the answer is that it would not, in any way, affect that liability.

    Second, as to whether or not the President's Working Group supports this bill, indeed, this is an implementation of one of the recommendations in the Working Group report. It was signed by all the members of the Working Group, and so the Working Group does support this bill.

    On the international front, there has been a great deal of dialogue among our counterparts in other countries about the Long-Term Capital situation and, indeed, about the recommendations that were put forward in the Working Group report and in this bill. I don't want to get ahead of the Financial Stability Forum report, which will be out in a few weeks, but we do understand that it will broadly be supportive of the recommendations in the President's Working Group report, and, indeed, of this bill. And there will be coordination among all the participants in that forum to try and establish similar procedures in other jurisdictions.

    As far as my experience in the markets goes, I guess—and what impact I think this might have, I would say a couple of things. First, more broadly on transparency, in my experience, and all market participants' experience, transparency is clearly one of the great strengths of our market. And, indeed, if you look overseas, certain overseas markets that have less transparency than our own, the cost of capital is significantly higher. Clearly, there are a variety of reasons for that. One of them is certainly the lack of transparency.

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    As far as the impact of this legislation potentially causing institutions to operate offshore, we do not view this legislation as regulation. We don't view this as regulating hedge funds or anyone else.

    All this is very simply the disclosure of basic summary financial information of the largest hedge funds. This is not a burden to the funds. This is information that they compile, that they currently provide to their investors and to their counterparties.

    So in terms of an added burden, it's minimal. All this would do is simply provide that limited summary financial information to the markets more broadly so that the markets can effectively impose market discipline.

    Mr. BENTSEN. And my time is really about up. But I do want to say the information that is requested in the manager's amendment that would then go to the Fed and then the other regulators in the Working Group you stated, and I just glanced at it earlier, but it is financials that are GAAP, or GAAP-style financials. You don't think we are creating a situation where the Fed ultimately could write regulations that establishes new types of tests, new types of risk analysis tests that ultimately we are going to have the hedge fund industry coming to Congress and saying, ''You know, the Fed is out of control now. They are making us run all these tests, run all these hoops to come up with this otherwise non-proprietary information as part of this legislation.'' You don't see that happening in this?

    Mr. SACHS. I do not see that happening, Congressman.

    Chairman BAKER. If I can, Mr. Bentsen, I need to move on.
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    Mr. Manzullo.

    Mr. MANZULLO. I have a question of both of you, Mr. Sachs, and Chairman Baker. It stems from your comment, Chairman, of protecting your parents' pension funds. Can either of you elaborate on what you meant by that?

    Chairman BAKER. I would be happy to. You might find Mr. Sachs a more credible source. My concern is the systemic implications of the failure of Long-Term are unknown. But had Long-Term not been saved by the actions of the Fed, there is some belief by people that the ripple effect through other financial institutions and other investors would have been broad based and significant and, without argument, significantly depleting the value of many individuals who had no direct relationship to LTCM, the value of their assets.

    That is my concern, innocent third parties who don't know an LTCM from a Peat Marwick who are minding their own business and find their net worth impacted by the actions of high rollers. I don't care whether they make money or lose money. I don't care if there are hedge funds. And I don't mean that in a market sense. They are a valuable asset to our economy. But what I mean is whether they succeed or fail is not the importance of this bill. What is important is folks who have no interest in nor relationship to should not be adversely impacted by the risk-taking business.

    And I liken it to a Louisiana problem which many Members of this subcommittee have enjoyed over the years crediting me with is separations of S&L operators caused the taxpayers to pay large sums of money for activities they have no control or interest in.
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    Mr. MANZULLO. Then you have made the argument to regulate.

    Chairman BAKER. No, I have not. I made the argument to disclose because I am a free market guy. I don't think the Government knows best, but I think the investor should have the information to make a decision. This does not provide regulation, it provides information.

    Mr. Sachs, do you want to jump in?

    Mr. SACHS. I don't have much to add to that. I concur with everything that the Chairman said in response to that question. Just in regard to the last point, this is a very free market approach. This is not a Government telling anyone what they can or cannot do.

    Mr. MANZULLO. Well, it is. I mean, there is a provision at the end of the bill to go to the U.S. District Court to force the disclosure. And the issue there would be if there is a disagreement over the nature of the disclosure. I mean, when you talk about free market then talk about going to court to keep the market, I mean I just—I have some problems.

    But let me ask you a question. If a company gets involved in an investment and doesn't do the homework, doesn't do the research, isn't it a breach of fiduciary duty to the investors?

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    Mr. SACHS. I don't know if it is a breach. I don't know about whether or not it is a breach of fiduciary duty.

    Mr. MANZULLO. I mean, it's bad investment practice, wouldn't it be, to make an investment not doing the research?

    Mr. SACHS. Yes.

    Mr. MANZULLO. Isn't that what we are talking about here is people getting involved, not doing the research?

    Mr. SACHS. But as the Chairman pointed out a moment ago, it's not necessarily—it's not the investors in these funds that anyone is trying to protect. If someone wants to make an investment in these funds or lend money to these funds or engage in a transaction with these funds without doing their homework, because of complacency or some other reason, that is their problem, frankly. It is the folks that are not directly engaged in business with these institutions who are potentially impacted by their demise through no fault of their own.

    Mr. MANZULLO. Could you explain that?

    Chairman BAKER. Mr. Sachs, if we could be more specific, for example, if a shareholder for 100 shares of Bank XYZ that extends credit to an LTCM operation. The shareholder of the bank has no knowledge of the investor portfolio of the bank, would have no reason today to know anything about the risk, and the bank has significant losses, thereby affecting the value of those shares. Those shares could be held by a pension fund. And the consequence is much more widespread than a single investor. And in that case, none of the harmed parties have any relationships to the hedge fund activity and would have no way to find out.
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    Mr. MANZULLO. But that is a classic derivative shareholders' action for breach of fiduciary duty, because the bank did not make the adequate inquiry into the nature of that investment. It is always that way. That would apply to any bank, to any group that lends money out.

    Chairman BAKER. Well, the remedy, if I might, Mr. Manzullo, is not to provide an actionable cause for further litigation. It is go to the front end of the train and to give people information with which they can make their own business judgment.

    Mr. MANZULLO. Chairman, if your folks had owned 100 shares in Bank XYZ, as part of their 401-K, for example, and the 401-K actually would be the record shareholder, are the 401-K trustees or your parents going to be looking at these disclosure statements made by the bank when they don't even know what the bank is investing in?

    Chairman BAKER. My response would be more information is not going to make the loss more likely, it will make the loss less likely. This does not require the hedge fund to do anything other than, every 90 days, if they are leveraged, if they are of a certain size, do generally accepted accounting principle reports that the Fed says is not proprietary.

    Now, would that save everybody from future loss? No. Does it enable somebody to preclude future losses? Yes. And to simply say that these activities can be engaged in, recognizing the potential for systemic risk that the regulators have identified, without providing public information about their risk analysis, I think is not good public policy. And I think we can safely say I am pretty much a free market kind of guy. But this is bumping up against reasonable limits.
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    Mr. SACHS. The only thing that I would add, and perhaps this has been said, is that I agree with all the comments that the Chairman just made. But I would also add that public disclosure of the nature that we are discussing now just—it shines light on these institutions. And that in itself exerts market pressure on creditors to do their homework.

    The other provision that—one of the other recommendations in the bill, and it is referred to in this legislation, is that large financial institutions who have exposure to hedge funds and other highly leveraged institutions disclose that they have that exposure. So the discipline that the market would be exerting would be coming from the shareholders that you are talking about and other participants in the market. We can't just rely on the individual counterparties. It has to be market forces more broadly.

    Chairman BAKER. Thank you, Mr. Manzullo.

    Any questions from the Democrat side?

    Mrs. Maloney.

    Mrs. MALONEY. I support disclosure, and I am going to support the bill. But I thought that Mr. Toomey raised an important point when he stated earlier that he was concerned that the disclosure would put a business at a competitive disadvantage internationally and nationally by disclosing such information that one might determine their business strategy. And you have said that it will only be—proprietary information will not be disclosed. But I really feel that we need more explicit information in that area to make sure that the public and other people know about it.
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    Chairman BAKER. Mrs. Maloney, if I may, on that specific point, you don't have it in front of you yet, but the manager's amendment suggested by the regulators, I think specifically the Fed, contains this language: ''provided that no such regulator shall require an unregulated hedge fund to reveal proprietary information.''

    That clearly was their intention, but there is now a statutory provision that would protect the hedge fund from disclosure by simply raising this is proprietary, therefore——

    Mrs. MALONEY. But I think you need more explicit definition of what is proprietary, I would say. But I do support disclosure, and I believe if we had it, we would not have had the Long-Term Capital bailout.

    Would you like to comment?

    Mr. SACHS. Sure. I would be happy to comment. First, in terms of putting these funds at a potential competitive disadvantage, we do not, in any way, think that the information contemplated in this legislation would put anyone at a competitive disadvantage.

    Banks, securities firms, broker-dealers, all release more, and, frankly, much more information than is being contemplated here. And I don't believe anyone would argue that our financial institutions are at a competitive disadvantage vis-a-vis the rest of the world as a result of that.

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    Second, it is important to note that as this legislation contemplates, the Fed would be proposing rules for public comment. They would be drafting rules. They would issue a proposed rulemaking. And the contents of that proposal would be discussed with the private sector. I am sure interested Members and any other interested parties will assure that the proper balance is struck.

    Mrs. MALONEY. OK. Thank you. Well, the Fed has contended that, because the recapitalization of Long-Term Capital was done with private money, that it wasn't a bailout. Many people disagree. The Fed was the primary Federal regulator for many of the institutions that were involved, they were called to support Long-Term Capital and the meetings took place at the normal Fed office.

    Do you think that, as part of this disclosure, the Fed should have to disclose to the public when it is acting as a virtual work-out artist for an entity that is not insured by the FDIC?

    And, again, I want to come back to another question that many people have raised, and that is the danger that, by having the Fed act as the pass-through, that the markets will assume that if you invest in these risky financial funds, there is an implicit guarantee of Government bailout. What do you think of notice from the Fed if they are going to be acting as a work-out artist?

    Mr. SACHS. I will say a couple of things. First, in regard to the activities surrounding Long-Term, we do not view those activities as a bailout by the Federal Reserve. It was, as you indicated, private sector, private market participants who determined, frankly, that it was in their own best interest to take the actions that they took.
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    As far as whether or not the Fed's role as a pass-through agent, the Working Group was very careful and suggested some amendments which have been incorporated in the manager's amendment to assure that the market understood that they are not in this context a regulator.

    They are not a regulator of hedge funds. Their role is purely to pass the information to the public so that the public and the markets can make informed investment decisions.

    This does not implicate them or suggest to them that they need to take action. In fact, it doesn't give them any different authority than they have in today's world in that regard. And we do not believe that this legislation impacts that in any way. In fact, we believe that the enhanced transparency and disclosure of information may serve to reduce the likelihood that they would ever be in that situation anyway.

    Mrs. MALONEY. But do you think it would be appropriate to require the Fed to make a disclosure prior to any such meetings where they are calling groups together, not to bail them out, but to let them know that the regulator thinks it is in their best interest to do certain things?

    Mr. SACHS. Congresswoman, I am not sure what public policy would necessarily be served by causing the Fed to disclose that they are meeting with private sector entities.

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    Mrs. MALONEY. To bail them out—I mean, to encourage them—I mean, that was a major, shocking event to have the Central Bank basically restructure a deal that would have failed if they had not intervened. And it—many people may see that as a precedent and as a security blanket in the future, and it is a major policy step. And you—in other words, you would be opposed to any disclosure of meetings of this sort in the future?

    Mr. SACHS. I would hope that—and I don't want to speak for my friends at the Fed, but I would certainly hope that the market does not take comfort that if another hedge fund were to get into trouble, that a similar outcome would be the result. No one knows what could happen in the future. But no one should necessarily view this as precedent. Again, I don't want to speak for them. That is just our view.

    Chairman BAKER. Thank you, Mrs. Maloney.

    Any further questions?

    Mr. Toomey.

    Mr. TOOMEY. Thank you, Mr. Chairman.

    I would like to go to what I think is the heart of the difficulty with this legislation. It is manifested by this discussion over the question, what is proprietary?

    Rather than requiring a very limited summary of financial information to be disclosed, it seems to me, if we look at page 5, at section 4(a)(2), line 5, it requires a meaningful and comprehensive measure of risk, such as Value At Risk or stress test results to be provided. And then at point number 3, such other information as the board in consultation with all the other regulators may require by regulation.
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    So it seems to me that what this legislation is saying is, we want to have a meaningful and comprehensive analysis of the risk profile of this fund. And it strikes me that that is—by its very nature—reveals the content of that fund, in a general sense, certainly—not necessarily individual securities, but in a very general sense, in order for it to be meaningful, it must disclose that, and that is the inherently proprietary, how do we distinguish?

    Mr. SACHS. Congressman, if I can give an example, and then come back to your specific question on points number 2 and 3.

    It is not required currently that financial institutions disclose things such as Value at Risk—VAR. However, many choose to do so on their own, not because—obviously, not because they think it would put them at a disadvantage, but they see the benefits in disclosing this type of information to show what risk they have, so that the marketplace understands that they are not out of control and overly leveraged. And these are some of the largest securities firms in our markets.

    Mr. TOOMEY. But they are in a different business than the business that hedge funds are in.

    Mr. SACHS. They are in a broader array of businesses.

    Mr. TOOMEY. Right.

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    Mr. SACHS. But the firms that I know of that do this have substantial businesses that, if you carve them out of the investment bank itself, would look very much like a hedge fund. And, in fact, if all you were doing was looking at the positions and financial information, it would be difficult, perhaps very difficult to distinguish.

    Mr. TOOMEY. But when you look at the nature of their business and where their other revenues come from, from the sales of securities and underwriting and consulting and investment banking, management fees, and all kinds of commissions and other things, they are much broader than this.

    The purpose, to a large degree, of hedge funds is to engage in proprietary trading. As you know, a lot of these hedge funds are folks that are—they hire folks who have Nobel Prizes in economics, they have Ph.D.s in physics and all kinds of advanced ability to analyze, all based on the assumption that because of their expertise, they are able to get out a little bit in front of the rest of the market in exploiting inefficiencies, anomalies, things that will generate profits for their investors.

    And if you are going to require meaningful information about that portfolio to be disclosed, you are going to shed light, you are going to reveal what their strategies are, and thereby undermine their ability to engage in what is their very stock in trade.

    You mentioned if this legislation were in effect prior to the Long-Term Capital Management episode it might have prevented that. Well, in order to have prevented that, it must reveal a great deal of information about their portfolio. That portfolio had exposure to things such as interest rates, currency fluctuations, yield curve shifts, changes of volatility of all of the above, relative value of similar securities.
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    If you provide an analysis that reveals the nature of exposure to those positions, you are shedding an awful lot of light on the nature of the portfolio and thereby undermining the competitive advantage this firm has vis-a-vis a foreign firm that wouldn't have to disclose this. I don't see how we avoid that.

    Mr. SACHS. Congressman, I appreciate the point. We all have to be quite careful in ensuring that the information that is disclosed does not put these funds at a competitive disadvantage.

    Without getting into too much detail at this point, a measure of risk like Value at Risk is only a measure of how much an entity would stand to gain or lose over a period—could stand to gain or lose over a period of time, given certain volatility. That number does not indicate that someone has exposure to Russian government bonds or interest rate exposure or commodities or what have you. It does give you a sense of how much they could make or lose over a period of time.

    Mr. TOOMEY. Well, I think when we say meaningful and comprehensive measures of risk, such as Value at Risk or stress test results and such other information as the Board and the other regulators may require, I think it certainly raises the prospect that we could be forcing institutions to reveal a great deal of information that does compromise their ability.

    And I would like to move on to another point, because I have limited time. Did you want to respond?
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    Mr. SACHS. Yes. I am sorry, Congressman.

    If I can just touch on that item number 3, as I indicated before, the art of risk measurement and risk management is evolving quite rapidly and will continue to evolve over time. This was intended just to give flexibility to the extent that the markets come up with a new, better, more efficient way to measure risk, without revealing proprietary information, and that the Fed could use that measure.

    We don't know what is going to be created. And rather than coming back to Congress and asking for a change in legislation that would allow them to take advantage of new technology, we just allow them to do so via the rulemaking process.

    Chairman BAKER. If you can wrap up with the next question, because I have a couple more Members to be heard.

    Mr. TOOMEY. I will try.

    The evolving nature of the risk management is a very important point. But I think it has been evolving quite naturally in the marketplace and extremely effectively. The banks you pointed out perhaps didn't obtain all the information they might have prior to the Long-Term Capital Management episode. But I think it is hard to argue they are not doing that now.

    I have spoken to a number of financial institutions that extend credit to hedge funds. They are very proud of systemic overhauls of the way they evaluate this risk. And I think it is institutionalized; I don't think it is something that is going to be neglected in a short amount of time.
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    The last question I wanted to raise was with regard to the slippery slope. I think there is a very real danger that the logical outcome of this is more regulation, because what we are saying is, we need to know the amount and nature of risk. That clearly implies that there is a point above which the risk is excessive.

    If that is the case, how can the Fed sit by and allow excessive risk to be jeopardizing our financial system? Certainly that would be imprudent and irresponsible of them. I don't know how they would not feel obliged to step in and actually start putting limits on these things.

    Mr. SACHS. I guess I would just say a couple of things.

    As far as the slippery slope goes, we would not be supportive of—we are not supportive of further regulation. I don't believe—again, I don't want to speak for everyone in the Working Group, but my sense, having discussed this a great deal with a number of staff from the Working Group agencies, is that there isn't a member of the Working Group that would support further regulation. We would not be here endorsing a bill that went further than this one.

    Mr. TOOMEY. That is today. But thank you very much.

    Thank you, Mr. Chairman.

    Chairman BAKER. Mr. Capuano, you had a question.
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    Mr. CAPUANO. Thank you, Mr. Chairman, I had a couple questions, a couple of comments.

    I guess I am sitting here amazed today that in light of the SEC and the Commodities Futures Trading Commission and the Fed, the Treasury, with all that regulation, I am absolutely shocked that we can be sitting here in the best economy in the history of mankind, how could that possibly have happened with Government regulators looking over the shoulders of wonderful, absolutely pure perfect people in private enterprise? I just don't get it. But I guess I have a lot of learning to do, because I always thought that general public knowledge was a good thing.

    And I understand the hesitancy to regulate something that we don't quite understand yet, and I have my hesitancies about that as well.

    I guess I am the only person left in America who is not terribly worried about a little regulation when you are talking about not a few wealthy people. I don't care. I do care about the economy. I do care a little bit—even more than my mother's pension, I am worried about my pension and my kid's pension, because we are talking about the potential here of the entire American economy falling because nobody is looking at anybody.

    I know that is maybe a little overstatement of the truth, but that is what we are here to do is to try and prevent that from happening, particularly when—maybe I am wrong, but the last information I had is that the average hedge fund only existed for three years. By the time the market gets up to speed about what the new theories are and the new Nobel Prize winners think are good for us, they will already have completely screwed up the economy by the time the market gets around to regulating itself, because they are gone, and a whole new thing comes into place.
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    Now, if it was a little bit more stable, maybe you can make the argument. But only a three-year average lifetime, it is absurd to think somebody is going to come in and be nice about it without at least us knowing about it.

    I don't have any real problem with it. I actually think this is probably the least, minimal step you can come do; and in a few years, the next time some problem occurs, look at yourselves in the mirror and say, we tried to do something, we tried to prevent it.

    So I support this legislation at the same time. I think it is the least we can do.

    I do have a few questions, particularly relative to, right now, your best guess—knowing full well you don't have the information, but your best guess—how much money do you figure is involved if you took every hedge fund in America and added it up, what is your guess of the amount of money we have? Make up a number.

    Mr. SACHS. I don't have any numbers on that.

    Mr. CAPUANO. We do.

    Mr. SACHS. Perhaps you could share it with the witness. No. I had seen some numbers at some point on this. I believe that estimates we have seen from the private sector, that there are somewhere on the order of 3,000 hedge funds, and they have an average of, I believe it was somewhere—it was well less than $100 million each.
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    Mr. CAPUANO. I lose my zeros there. So $3 trillion? Trillions? Billions? Trillions?

    Mr. SACHS. I have a sheet here that may be helpful.

    Mr. CAPUANO. Quick math.

    Mr. SACHS. Someone has made an estimate that there is somewhere around $800 billion.

    Mr. CAPUANO. $800 billion. Of that, how much would be included in those top 25 hedge funds, roughly?

    Mr. SACHS. The top 25 is approximately 24 percent of all assets—of all.

    Mr. CAPUANO. Good enough. So 75 percent of the entire hedge fund world will be completely, not just unregulated, but completely free to do whatever it wants, as it has been doing since the beginning of hedge funds.

    Mr. SACHS. That is correct. But we, just to be clear, we do not see that it as consequential that any one of those small firms could collapse. That is up to the—that is part of our system, the financial institutions have to be allowed to fail.

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    Mr. CAPUANO. I respect that to a certain extent. They are allowed to fail as long as they fail on their own without dragging me down with them. And that is, I think, why we are here, because if they weren't dragging anybody down with them, we wouldn't be here. We wouldn't be concerned about Long-Term. It would have been a couple of rich people who lost a few bucks. Tough luck.

    We are here because we were concerned about the potential. How large or how small that fund has to be to raise that risk I think is a fair question. I respect the fact that very knowledgeable people think what we are doing now is OK, especially less than 1 percent of the funds is what we are covering, less than 25 percent of the dollars. Good place to start. Hopefully, it will work.

    I guess the other—at some point, as we talked earlier, Mr. Secretary, I would like to see some numbers at some point, if we were to regulate the top 2 percent—not 20, 2 percent—namely 60 funds, the top 5 percent, 150 funds, not today, that's fine, but at some other time, I would appreciate seeing those numbers.

    Mr. CAPUANO. As the last point for me, the words that I tripped over the most in this amended version, though I will still support it, are the words on page 2 of the amendment before us, on lines 21 and 22, that the board may exempt by regulation, and it goes on to say, pretty much anybody they want to.

    So if these 25 funds, for all intents and purposes, the board can say, we don't want to do 25 funds, we only want to do one. And there is nothing here that says we can put a floor. That is the way I read this; now correct me if I am wrong.
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    Mr. SACHS. The intention there is that we don't know what types of investment vehicles people will create in the future. And to the extent that the definition in the bill unintentionally captures a type of vehicle that could not in any way pose risk to the system, we thought it would be appropriate to have the Fed allow that institution not to, not to go through this process.

    Mr. CAPUANO. I understand that when you write legislation you can never catch everything that you want, especially in this area where it is brand new to us. I respect that. But at some point in time, I would like to see some things in writing from whoever you think is appropriate, relative to what kinds of people you would expect might ever someday be exempted.

    The only reason I do that is, when the time comes for the board to make some exemptions, I would like to be sitting here—I intend to be sitting here—to say, ''Gee, that is not what you told us,'' or, ''It is what you told us a year ago, two years ago, ten years ago.'' As I interpret it, simply allowing the board to exempt without any limit anybody they want, for all intents and purposes, Mr. Toomey wins. You can tomorrow say that ''We changed our minds and we don't want to regulate anybody. We exempt everybody.''

    Chairman BAKER. Mr. Capuano, if I can, we have been pretty liberal with our time.

    Mrs. Biggert.

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    Mrs. BIGGERT. Thank you, Mr. Chairman. I wanted to go back again to the role of the Fed and the Working Group. If we ask for the requirement to file some sort of a report, and let's assume that the Federal Reserve or the Working Group thinks that there really is a problem with that hedge fund, that it is overextended, overleveraged, and there is going to be a problem, what happens then under this bill?

    Mr. SACHS. This bill has no impact on any action that anyone can take with respect to one of these hedge funds.

    Mrs. BIGGERT. Then why do we have to have this disclosure?

    Mr. SACHS. The disclosure is intended to enhance transparency, and, therefore, market discipline. Market forces tend to constrain excesses. Most Members who have spoken today have talked about—regardless of where they are on this particular bill, have talked about the importance of transparency and the fact that greater transparency tends to reduce the cost of capital and improve the efficiency of our financial markets. That is what we are attempting here, not to suggest that any regulator, Fed or otherwise, should take any action or could take any action.

    Mrs. BIGGERT. Well, my concern is that, if the regulator has seen this, they required it and have done nothing, is there potential for liability then against the regulators and, in effect then, the U.S. for not disclosing that they see this as a problem?

    Mr. SACHS. This legislation does not contemplate the regulators saying anything about any of these institutions. All this does is release summary public information about only those few largest hedge funds that can potentially have an impact on the system, should they fail. It does not suggest or imply that the Fed has any additional responsibility or authority with respect to those hedge funds.
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    Mrs. BIGGERT. Well, I can see that with the market themselves disclosing their information, there is no control. But is there an issue of control then by the regulators and the Working Group? I mean, we won't see the rules and regulations that will follow this until after this bill is passed.

    Mr. SACHS. There is no control by the regulators of these funds. We should be perfectly clear about this. If there—if this bill—if we thought this bill was implying that, I don't think you would see us sitting here today, supporting it as we are. It is not our intention that there is any control by regulators over hedge funds.

    Mrs. BIGGERT. Well, there is an issue then of what is the proprietary information that can be included and what can go to the public. Would there be more information that would go to the Federal Reserve and to the Working Group than is actually given out to the public?

    Mr. SACHS. Absolutely not. In fact, that is one of the—I believe it is in the manager's amendment that has been put forward by the Chairman and Mr. Kanjorski. It specifically says that the information that the Fed receives, it passes on to the markets. That was important to the Fed and to the Working Group that there not be a perception that the Fed has information that the market doesn't have.

    Mrs. BIGGERT. OK. That is all. Thank you.

    Chairman BAKER. Thank you, Mrs. Biggert.
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    Mrs. Jones.

    Mrs. JONES. Good afternoon. As part of the Working Group, were there representatives of hedge funds or people who operate in that arena?

    Mr. SACHS. As part of the Working Group?

    Mrs. JONES. Yes.

    Mr. SACHS. No. The Working Group was just the Chairman of the Federal Reserve, the Secretary of the Treasury, the Chairmen of the SEC and the CFTC.

    Mrs. JONES. OK. But they had an opportunity to be heard on these issues, correct?

    Mr. SACHS. I am sorry?

    Mrs. JONES. People who operate the hedge funds, the people who we really don't know who they are, because they don't step out and tell us who they are, had an opportunity to be heard with regard to this possible disclosure? Have they had—I mean, I haven't heard from them. So I am just curious.

    Chairman BAKER. Mrs. Jones, on that point, we extended an invitation to representatives of the industry to appear today, and that was not acted on.
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    Mrs. JONES. So they must not have any problem with this since they didn't take advantage of the opportunity to be heard or haven't called any of the Members of Congress.

    Chairman BAKER. I don't know. Somebody is on the phone.

    Mrs. JONES. They called you; they didn't call me. OK. Well, I am suggesting then that if they had an opportunity to appear, to be heard, and they did not, I presume that they, in fact, don't have such a big problem with this. So why should we have a problem with it?

    Mr. SACHS. As to their position, I suppose you would have to ask them. We do not have—I don't think you should have a problem.

    Mrs. JONES. I am not asking for their position.

    Mr. SACHS. I don't think you should have a problem with this legislation. We think it is good legislation and are supportive of its passage.

    Mrs. JONES. I personally don't have a problem. I am suggesting, if they wanted to be heard, they would be here and would be saying something, because any other time, they are bitching and screaming about whatever is going on, right? That was my only question. Thank you.

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    Chairman BAKER. I think Mr. Riley was next.

    Mr. RILEY. At the risk of alienating my Chairman who wants to move this along, there are a couple of questions I have to ask.

    Mr. Sachs, you said a moment ago that you hope no one took this as a precedent. Can you tell me, under a similar set of circumstances, would this never happen again?

    Mr. SACHS. I am sorry, would which never happen again?

    Mr. RILEY. Would we never have the Fed intervening in something like Long-Term Capital? Can you give me an assurance that that would never happen again?

    Mr. SACHS. Well——

    Mr. RILEY. If you can't do that without a smile on your face, I think that pretty well answers the question.

    I guess my problem is, we have set a precedent. We have already stated in this country that if and when—you said a moment ago that small groups have to be able to fail. I think that is a very telling comment. I think that is the policy in this country today that small groups can fail. But we have set a precedent that we will not let a large hedge fund fail, and for all the right reasons.

    To go back to what some of my colleagues had asked just a moment ago, when we talk about competing with foreign entities, can you imagine a scenario where our Fed would intervene in the restructuring of a foreign hedge fund?
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    Mr. SACHS. Congressman, I do not—it is hard for me to envision a scenario in which the Fed or anyone else would have to act on behalf of a foreign hedge fund.

    Mr. RILEY. We know and we do have precedent now that we will intervene in an American hedge fund, now you can call it a precedent or not, we have done it once, and if the fund is large enough, there is absolutely no doubt in my mind that we wouldn't do it again. So I think we have to treat foreign hedge funds somewhat differently than we do the ones in the United States.

    I cannot think of a less restrictive bill coming before this subcommittee. The only thing that we are asking is that you just have some transparency. I don't even believe this is going to be an incremental step. I cannot imagine that you could write any bill that would have less restrictions.

    But if you want to play with the big boys, if you want to play in the big leagues, and if you want to take these risks there is a possibility if you get in trouble, the Fed will bail you out, then I think this is the most minimal bill we could ever pass.

    I think it is just inconceivable that we sit here and let it happen again a year from now and come back and say, ''Well, why didn't we do something?'' This is something, and I cannot imagine why anyone would have a problem with doing this very, very small amount.

    Mr. SACHS. Congressman, I certainly agree with that last point you made. This bill is designed primarily so that market forces can act in such a way as to reduce the likelihood that the Fed or anybody else would be in a position to have to——
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    Mr. RILEY. Unless we want to make Alan Greenspan the Big Brother that oversees all hedge funds—which is where I think we are going to be if we don't pass this—this gives enough transparency so people can do it. I think every time it is either that or we restrict the size of the hedge funds, and I don't think anyone in here wants to do that.

    Mr. SACHS. No, sir.

    Mr. RILEY. So given those two options, I cannot imagine someone would not vote for this bill.

    Thank you, Mr. Chairman.

    Chairman BAKER. Thank you, Mr. Riley. I appreciate your remarks.

    Mr. SACHS. Mr. Chairman, can I make one comment on the precedent issue, because I think it is important that everybody recognize—market participants—recognize that this should not be viewed as a precedent, and that they should not necessarily expect the Fed or anyone else to act if hedge funds were to get into trouble in the future.

    Mr. RILEY. Can you define what a precedent is? A precedent is something that has happened once and we have taken action because of certain implications it would have on our market structure. And I guess if we can't say that this is a precedent, then I hope that somebody can, with your Working Group or on this subcommittee or somebody, can tell me that it can never happen again, because we have not limited the size of it, we have not limited the volatility of it, we have not limited the exposure, we have not limited the risk. So if it happened once, why would it not happen again?
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    Mr. SACHS. Congressman, no one can say with absolute certainty what can happen in any future set of events. I just want to emphasize that market participants should not expect that any particular remedy will occur.

    Mr. RILEY. I think, Mr. Sachs, that we would all be very naive if we didn't understand that the very large hedge funds know what happened before and they know what the market conditions would do if they failed again, and I think everyone in this room and everyone in these hedge funds understands what the Fed, even if you didn't want to, would happen.

    Chairman BAKER. Thank you, Mr. Riley.

    Mr. Ryan, did you have another comment?

    Mr. RYAN. Yes, I have just one quick question. But I just wanted to make an observation.

    Mr. Sachs, in your answer to my question earlier about the slippery slope concern, you mentioned that that would be largely determined on what Congress does and the attitude of Congress. I think just this hearing today kind of reveals the fact that on both sides of the aisle Members have strong opinions that this is the least we should do, this is the minimal effort we should make. I think that point, in and of itself, lends credence to the concern of the slippery slope, given the fact where some Members want to go. That's really an observation, not a question.

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    The question I have is probably more directed for Chairman Baker.

    Chairman Baker, I am just curious, why were the trigger levels set? Why were they changed in the manager's amendment? In the base text of the bill, the aggregate total assets were set at $20 billion, I believe, in the beginning. The net aggregate assets were set to $3 billion. In the manager's amendment, it is reduced to $3 billion total for the assets and $1 billion for the net assets.

    What was the reason for doing that?

    Chairman BAKER. Extensive discussion with the regulators that the definition initially proposed by me was insufficient to capture the risk that is apparent in the market, and that if we are going to provide for the disclosure, we really ought to do it down to a point at which someone can assume, if these fail, there is a potential for systemic risk. That really is a very artful line that is drawn.

    I will say this for the record: that what is contained in this legislation is minimalist, and I will not support going any further than what this bill proposes. And certainly in my conversations with members of the Working Group, they will not go further than what this legislation proposes.

    One other little point that, since you have opened the door for me, there has been a view represented that affiliates of banks and securities interest would be subject to these provisions, and that is not accurate. The bill only applies to currently unregulated financial enterprises that are defined as ''hedge funds'' by this legislation.
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    And, in fact, the current level of regulatory constraint is far worse than what this bill proposes. This is not regulatory constraint; it is merely disclosure.

    So I just wanted to get that on the record, because apparently some folks have had that idea. Thank you very much. Is there any further discussion?

    We have officially ended our hearing.

    Thank you, Mr. Sachs, for your testimony this morning and your patience.

    [Whereupon, at 12:35 p.m., the hearing was adjourned.]