Monthly Archives: September 2009

Obama on Financial Reform

President Discusses Future Financial Regulations in Advance of G20

Earlier today President Obama gave a speech in New York discussing the administration’s future plan for greater regulation of the financial markets in the wake of the financial crisis of 2008/2009.  Speaking strongly the President said:

So I want everybody here to hear my words:  We will not go back to the days of reckless behavior and unchecked excess that was at the heart of this crisis, where too many were motivated only by the appetite for quick kills and bloated bonuses.

And we intend to pass regulatory reform through Congress.

Of course no political speech about the financial crisis will fail to take a swipe at the hedge fund industry.  Obama took this opportunity to say that hedge funds “can operate outside of the regulatory system altogether.” Oft-repeated statements like these not only grossly mischaracterize the current regulatory system, but also unjustly serve to cast hedge funds as a progenitors of the financial crisis. [HFLB Note to President Obama – if you give me a call I am happy to give you a brief overview of how hedge funds are currently regulated under the securities laws.]

While there is really nothing new in this speech, it does drive home that increased financial regulation is likely coming soon.  I have reprinted the entire speech below and it can also be found here.



Office of the Press Secretary

For Immediate Release
September 14, 2009


Federal Hall
New York, New York

11:59 A.M. EDT

THE PRESIDENT:  Thank you very much.  It is wonderful to be back in New York after having just been here last week.  It is a beautiful day and we have some extraordinary guests here in the Hall today.  I just want to mention a few.

First of all from my economic team, somebody who I think has done extraordinary work on behalf of all Americans and has helped to strengthen our financial system immeasurably, Secretary Tim Geithner — please give him a big round of applause.  (Applause.)  Somebody who is continually guiding me and keeping me straight on the numbers, the chair of the Council of Economic Advisers, Christina Romer is here.  (Applause.)  We have an extraordinary economic recovery board and as chairman somebody who knows more about the financial markets and the economy generally than just about anybody in this country, Paul Volcker.  Thank you, Paul.  (Applause.)  The outstanding mayor of the city of New York, Mr. Michael Bloomberg.  (Applause.)  We have Assembly Speaker Sheldon Silver is here, as well; thank you.  (Applause.)

We have a host of members of Congress, but there’s one that I have to single out because he is going to be helping to shape the agenda going forward to make sure that we have one of the strongest, most dynamic, and most innovative financial markets in the world for many years to come, and that’s my good friend, Barney Frank.  (Applause.)  I also want to thank our hosts from the National Park Service here at Federal Hall and all the other outstanding public officials who are here.

Thanks for being here.  Thank you for your warm welcome.  It’s a privilege to be in historic Federal Hall.  It was here more than two centuries ago that our first Congress served and our first President was inaugurated.  And I just had a chance to glance at the Bible upon which George Washington took his oath.  It was here, in the early days of the Republic, that Hamilton and Jefferson debated how best to administer a young economy and ensure that our nation rewarded the talents and drive of its people.  And two centuries later, we still grapple with these questions — questions made more acute in moments of crisis.

It was one year ago today that we experienced just such a crisis.  As investors and pension-holders watched with dread and dismay, and after a series of emergency meetings often conducted in the dead of the night, several of the world’s largest and oldest financial institutions had fallen, either bankrupt, bought, or bailed out:  Lehman Brothers, Merrill Lynch, AIG, Washington Mutual, Wachovia.  A week before this began, Fannie Mae and Freddie Mac had been taken over by the government.  Other large firms teetered on the brink of insolvency.  Credit markets froze as banks refused to lend not only to families and businesses, but to one another.  Five trillion dollars of Americans’ household wealth evaporated in the span of just three months.  That was just one year ago.

Congress and the previous administration took difficult but necessary action in the days and months that followed.  Nonetheless, when this administration walked through the door in January, the situation remained urgent.  The markets had fallen sharply; credit was not flowing.  It was feared that the largest banks — those that remained standing — had too little capital and far too much exposure to risky loans.  And the consequences had spread far beyond the streets of lower Manhattan.  This was no longer just a financial crisis; it had become a full-blown economic crisis, with home prices sinking and businesses struggling to access affordable credit, and the economy shedding an average of 700,000 jobs every single month.

We could not separate what was happening in the corridors of our financial institutions from what was happening on the factory floors and around the kitchen tables.  Home foreclosures linked those who took out home loans and those who repackaged those loans as securities.  A lack of access to affordable credit threatened the health of large firms and small businesses, as well as all those whose jobs depended on them.  And a weakened financial system weakened the broader economy, which in turn further weakened the financial system.

So the only way to address successfully any of these challenges was to address them together.  And this administration, under the outstanding leadership of Tim Geithner and Christy Romer and Larry Summers and others, moved quickly on all fronts, initializing a financial — a financial stability plan to rescue the system from the crisis and restart lending for all those affected by the crisis.  By opening and examining the books of large financial firms, we helped restore the availability of two things that had been in short supply:  capital and confidence.  By taking aggressive and innovative steps in credit markets, we spurred lending not just to banks, but to folks looking to buy homes or cars, take out student loans, or finance small businesses.  Our home ownership plan has helped responsible homeowners refinance to stem the tide of lost homes and lost home values.

And the recovery plan is providing help to the unemployed and tax relief for working families, all the while spurring consumer spending.  It’s prevented layoffs of tens of thousands of teachers and police officers and other essential public servants.  And thousands of recovery projects are underway all across America, including right here in New York City, putting people to work building wind turbines and solar panels, renovating schools and hospitals, repairing our nation’s roads and bridges.

Eight months later, the work of recovery continues.  And though I will never be satisfied while people are out of work and our financial system is weakened, we can be confident that the storms of the past two years are beginning to break.  In fact, while there continues to be a need for government involvement to stabilize the financial system, that necessity is waning.  After months in which public dollars were flowing into our financial system, we’re finally beginning to see money flowing back to taxpayers.  This doesn’t mean taxpayers will escape the worst financial crisis in decades entirely unscathed.  But banks have repaid more than $70 billion, and in those cases where the government’s stakes have been sold completely, taxpayers have actually earned a 17 percent return on their investment.  Just a few months ago, many experts from across the ideological spectrum feared that ensuring financial stability would require even more tax dollars.  Instead, we’ve been able to eliminate a $250 billion reserve included in our budget because that fear has not been realized.

While full recovery of the financial system will take a great deal more time and work, the growing stability resulting from these interventions means we’re beginning to return to normalcy.  But here’s what I want to emphasize today:  Normalcy cannot lead to complacency.

Unfortunately, there are some in the financial industry who are misreading this moment.  Instead of learning the lessons of Lehman and the crisis from which we’re still recovering, they’re choosing to ignore those lessons.  I’m convinced they do so not just at their own peril, but at our nation’s.  So I want everybody here to hear my words:  We will not go back to the days of reckless behavior and unchecked excess that was at the heart of this crisis, where too many were motivated only by the appetite for quick kills and bloated bonuses.  Those on Wall Street cannot resume taking risks without regard for consequences, and expect that next time, American taxpayers will be there to break their fall.

And that’s why we need strong rules of the road to guard against the kind of systemic risks that we’ve seen.  And we have a responsibility to write and enforce these rules to protect consumers of financial products, to protect taxpayers, and to protect our economy as a whole.  Yes, there must — these rules must be developed in a way that doesn’t stifle innovation and enterprise.  And I want to say very clearly here today, we want to work with the financial industry to achieve that end.  But the old ways that led to this crisis cannot stand.  And to the extent that some have so readily returned to them underscores the need for change and change now.  History cannot be allowed to repeat itself.

So what we’re calling for is for the financial industry to join us in a constructive effort to update the rules and regulatory structure to meet the challenges of this new century.  That is what my administration seeks to do.  We’ve sought ideas and input from industry leaders and policy experts, academics, consumer advocates, and the broader public.  And we’ve worked closely with leaders in the Senate and the House, including not only Barney, but also Senators Chris Dodd and Richard Shelby, and Barney is already working with his counterpart, Sheldon [sic] Bachus.  And we intend to pass regulatory reform through Congress.

And taken together, we’re proposing the most ambitious overhaul of the financial regulatory system since the Great Depression.  But I want to emphasize that these reforms are rooted in a simple principle:  We ought to set clear rules of the road that promote transparency and accountability.  That’s how we’ll make certain that markets foster responsibility, not recklessness.  That’s how we’ll make certain that markets reward those who compete honestly and vigorously within the system, instead of those who are trying to game the system.

So let me outline specifically what we’re talking about.  First, we’re proposing new rules to protect consumers and a new Consumer Financial Protection Agency to enforce those rules.  (Applause.)  This crisis was not just the result of decisions made by the mightiest of financial firms.  It was also the result of decisions made by ordinary Americans to open credit cards and take on mortgages.  And while there were many who took out loans they knew they couldn’t afford, there were also millions of Americans who signed contracts they didn’t fully understand offered by lenders who didn’t always tell the truth.

This is in part because there is no single agency charged with making sure that doesn’t happen.  That’s what we intend to change.  The Consumer Financial Protection Agency will have the power to make certain that consumers get information that is clear and concise, and to prevent the worst kinds of abuses.  Consumers shouldn’t have to worry about loan contracts designed to be unintelligible, hidden fees attached to their mortgage, and financial penalties — whether through a credit card or a debit card — that appear without warning on their statements.  And responsible lenders, including community banks, doing the right thing shouldn’t have to worry about ruinous competition from unregulated competitors.

Now there are those who are suggesting that somehow this will restrict the choices available to consumers.  Nothing could be further from the truth.  The lack of clear rules in the past meant we had the wrong kind of innovation:  The firm that could make its products look the best by doing the best job of hiding the real costs ended up getting the business.  For example, we had “teaser” rates on credit cards and mortgages that lured people in and then surprised them with big rate increases.  By setting ground rules, we’ll increase the kind of competition that actually provides people better and greater choices, as companies compete to offer the best products, not the ones that are most complex or the most confusing.

Second, we’ve got to close the loopholes that were at the heart of the crisis.  Where there were gaps in the rules, regulators lacked the authority to take action.  Where there were overlaps, regulators often lacked accountability for inaction.  These weaknesses in oversight engendered systematic, and systemic, abuse.

Under existing rules, some companies can actually shop for the regulator of their choice — and others, like hedge funds, can operate outside of the regulatory system altogether.  We’ve seen the development of financial instruments — like derivatives and credit default swaps — without anyone examining the risks, or regulating all of the players.  And we’ve seen lenders profit by providing loans to borrowers who they knew would never repay, because the lender offloaded the loan and the consequences to somebody else.  Those who refused to game the system are at a disadvantage.

Now, one of the main reasons this crisis could take place is that many agencies and regulators were responsible for oversight of individual financial firms and their subsidiaries, but no one was responsible for protecting the system as the whole — as a whole.  In other words, regulators were charged with seeing the trees, but not the forest.  And even then, some firms that posed a “systemic risk” were not regulated as strongly as others, exploiting loopholes in the system to take on greater risk with less scrutiny.  As a result, the failure of one firm threatened the viability of many others.  We were facing one of the largest financial crises in history, and those responsible for oversight were caught off guard and without the authority to act.

And that’s why we’ll create clear accountability and responsibility for regulating large financial firms that pose a systemic risk.  While holding the Federal Reserve fully accountable for regulation of the largest, most interconnected firms, we’ll create an oversight council to bring together regulators from across markets to share information, to identify gaps in regulation, and to tackle issues that don’t fit neatly into an organizational chart.  We’ll also require these financial firms to meet stronger capital and liquidity requirements and observe greater constraints on their risky behavior.  That’s one of the lessons of the past year.  The only way to avoid a crisis of this magnitude is to ensure that large firms can’t take risks that threaten our entire financial system, and to make sure that they have the resources to weather even the worst of economic storms.

Even as we’ve proposed safeguards to make the failure of large and interconnected firms less likely, we’ve also created — proposed creating what’s called “resolution authority” in the event that such a failure happens and poses a threat to the stability of the financial system.  This is intended to put an end to the idea that some firms are “too big to fail.”  For a market to function, those who invest and lend in that market must believe that their money is actually at risk.  And the system as a whole isn’t safe until it is safe from the failure of any individual institution.

If a bank approaches insolvency, we have a process through the FDIC that protects depositors and maintains confidence in the banking system.  This process was created during the Great Depression when the failure of one bank led to runs on other banks, which in turn threatened the banking system as a whole.  That system works.  But we don’t have any kind of process in place to contain the failure of a Lehman Brothers or AIG or any of the largest and most interconnected financial firms in our country.

And that’s why, when this crisis began, crucial decisions about what would happen to some of the world’s biggest companies — companies employing tens of thousands of people and holding trillions of dollars of assets — took place in hurried discussions in the middle of the night.  That’s why we’ve had to rely on taxpayer dollars.  The only resolution authority we currently have that would prevent a financial meltdown involved tapping the Federal Reserve or the federal treasury.  With so much at stake, we should not be forced to choose between allowing a company to fail into a rapid and chaotic dissolution that threatens the economy and innocent people, or, alternatively, forcing taxpayers to foot the bill.  So our plan would put the cost of a firm’s failures on those who own its stock and loaned it money.  And if taxpayers ever have to step in again to prevent a second Great Depression, the financial industry will have to pay the taxpayer back — every cent.

Finally, we need to close the gaps that exist not just within this country but among countries.  The United States is leading a coordinated response to promote recovery and to restore prosperity among both the world’s largest economies and the world’s fastest growing economies.  At a summit in London in April, leaders agreed to work together in an unprecedented way to spur global demand but also to address the underlying problems that caused such a deep and lasting global recession.  And this work will continue next week in Pittsburgh when I convene the G20, which has proven to be an effective forum for coordinating policies among key developed and emerging economies and one that I see taking on an important role in the future.

Essential to this effort is reforming what’s broken in the global financial system — a system that links economies and spreads both rewards and risks.  For we know that abuses in financial markets anywhere can have an impact everywhere; and just as gaps in domestic regulation lead to a race to the bottom, so do gaps in regulation around the world.  What we need instead is a global race to the top, including stronger capital standards, as I’ve called for today.  As the United States is aggressively reforming our regulatory system, we’re going to be working to ensure that the rest of the world does the same.  And this is something that Secretary Geithner has already been actively meeting with finance ministers around the world to discuss.

A healthy economy in the 21st century also depends on our ability to buy and sell goods in markets across the globe.  And make no mistake, this administration is committed to pursuing expanded trade and new trade agreements.  It is absolutely essential to our economic future.  And each time that we have met — at the G20 and the G8 — we have reaffirmed the need to fight against protectionism.  But no trading system will work if we fail to enforce our trade agreements, those that have already been signed.  So when — as happened this weekend — we invoke provisions of existing agreements, we do so not to be provocative or to promote self-defeating protectionism, we do so because enforcing trade agreements is part and parcel of maintaining an open and free trading system.

And just as we have to live up to our responsibilities on trade, we have to live up to our responsibilities on financial reform as well.  I have urged leaders in Congress to pass regulatory reform this year and both Congressman Frank and Senator Dodd, who are leading this effort, have made it clear that that’s what they intend to do.  Now there will be those who defend the status quo — there always are.  There will be those who argue we should do less or nothing at all.  There will be those who engage in revisionist history or have selective memories, and don’t seem to recall what we just went through last year.  But to them I’d say only this:  Do you really believe that the absence of sound regulation one year ago was good for the financial system?  Do you believe the resulting decline in markets and wealth and unemployment, the wrenching hardship that families are going through all across the country, was somehow good for our economy?  Was that good for the American people?

I have always been a strong believer in the power of the free market.  I believe that jobs are best created not by government, but by businesses and entrepreneurs willing to take a risk on a good idea.  I believe that the role of the government is not to disparage wealth, but to expand its reach; not to stifle markets, but to provide the ground rules and level playing field that helps to make those markets more vibrant — and that will allow us to better tap the creative and innovative potential of our people.  For we know that it is the dynamism of our people that has been the source of America’s progress and prosperity.

So I promise you, I did not run for President to bail out banks or intervene in capital markets.  But it is important to note that the very absence of common-sense regulations able to keep up with a fast-paced financial sector is what created the need for that extraordinary intervention — not just with our administration, but the previous administration.  The lack of sensible rules of the road, so often opposed by those who claim to speak for the free market, ironically led to a rescue far more intrusive than anything any of us — Democratic or Republican, progressive or conservative — would have ever proposed or predicted.

At the same time, we have to recognize that what’s needed now goes beyond just the reforms that I’ve mentioned.  For what took place one year ago was not merely a failure of regulation or legislation; it wasn’t just a failure of oversight or foresight.  It was also a failure of responsibility — it was fundamentally a failure of responsibility — that allowed Washington to become a place where problems — including structural problems in our financial system — were ignored rather than solved.  It was a failure of responsibility that led homebuyers and derivative traders alike to take reckless risks that they couldn’t afford to take. It was a collective failure of responsibility in Washington, on Wall Street, and across America that led to the near-collapse of our financial system one year ago.

So restoring a willingness to take responsibility — even when it’s hard to do — is at the heart of what we must do.  Here on Wall Street, you have a responsibility.  The reforms I’ve laid out will pass and these changes will become law.  But one of the most important ways to rebuild the system stronger than it was before is to rebuild trust stronger than before — and you don’t have to wait for a new law to do that.  You don’t have to wait to use plain language in your dealings with consumers.  You don’t have to wait for legislation to put the 2009 bonuses of your senior executives up for a shareholder vote.  You don’t have to wait for a law to overhaul your pay system so that folks are rewarded for long-term performance instead of short-term gains.

The fact is, many of the firms that are now returning to prosperity owe a debt to the American people.  They were not the cause of this crisis, and yet American taxpayers, through their government, had to take extraordinary action to stabilize the financial industry.  They shouldered the burden of the bailout and they are still bearing the burden of the fallout — in lost jobs and lost homes and lost opportunities.  It is neither right nor responsible after you’ve recovered with the help of your government to shirk your obligation to the goal of wider recovery, a more stable system, and a more broadly shared prosperity.

So I want to urge you to demonstrate that you take this obligation to heart.  To put greater effort into helping families who need their mortgages modified under my administration’s homeownership plan.  To help small business owners who desperately need loans and who are bearing the brunt of the decline in available credit.  To help communities that would benefit from the financing you could provide, or the community development institutions you could support.  To come up with creative approaches to improve financial education and to bring banking to those who live and work entirely outside of the banking system.  And, of course, to embrace serious financial reform, not resist it.

Just as we are asking the private sector to think about the long term, I recognize that Washington has to do so as well.  When my administration came through the door, we not only faced a financial crisis and costly recession, we also found waiting a trillion dollar deficit.  So yes, we have to take extraordinary action in the wake of an extraordinary economic crisis.  But I am absolutely committed to putting this nation on a sound and secure fiscal footing.  That’s why we’re pushing to restore pay-as-you-go rules in Congress, because I will not go along with the old Washington ways which said it was okay to pass spending bills and tax cuts without a plan to pay for it.  That’s why we’re cutting programs that don’t work or are out of date.  That’s why I’ve insisted that health insurance reform — as important as it is — not add a dime to the deficit, now or in the future.

There are those who would suggest that we must choose between markets unfettered by even the most modest of regulations, and markets weighed down by onerous regulations that suppress the spirit of enterprise and innovation.  If there is one lesson we can learn from last year, it is that this is a false choice.  Common-sense rules of the road don’t hinder the market, they make the market stronger.  Indeed, they are essential to ensuring that our markets function fairly and freely.

One year ago, we saw in stark relief how markets can spin out of control; how a lack of common-sense rules can lead to excess and abuse; how close we can come to the brink.  One year later, it is incumbent upon us to put in place those reforms that will prevent this kind of crisis from ever happening again, reflecting painful but important lessons that we’ve learned, and that will help us move from a period of reckless irresponsibility, a period of crisis, to one of responsibility and prosperity.  That’s what we must do.  And I’m confident that’s what we will do.

Thank you very much, everybody.  (Applause.)

12:29 P.M. EDT


Other hedge fund law articles related to President Obama and increased hedge fund regulation:

Outstanding Congressional Bills increasing financial regulation:

Bart Mallon, Esq. runs hedge fund law blog and has written most all of the articles which appear on this website.  Mr. Mallon’s legal practice is devoted to helping emerging and start up hedge fund managers successfully launch a hedge fund.  If you are a hedge fund manager who is looking to start a hedge fund, please call Mr. Mallon directly at 415-296-8510.

Pension Security Act of 2009

At the very beginning of this year a bill was introduced to change the Employee Retirement Income Security Act of 1974 (ERISA) to require defined benefit plans to disclose their interest in hedge funds.  The definition of hedge fund for the purposes of the act is very broad and would likely include private equity funds, VC funds, real estate hedge funds and other pooled investment vehicles.  In the event that this bill was passed the DOL is likely to issue regulations providing more color on how and in what manner the disclosures will be made.

The Pension Security Act of 2009 was part of a broader flurry of bills introduced this year which are designed to increase regulation of the investment management industry in general, and hedge funds specifically.  I have included the full text of the act below and have also provided links to the various other bills which have been introduced since the recession began.

A hat tip to Doug Cornelius at Compliance Building for reporting this story a couple of weeks ago.


Pension Security Act of 2009 (Introduced in House)

HR 712 IH


1st Session

H. R. 712

To amend title I of the Employee Retirement Income Security Act of 1974 to require in the annual report of each defined benefit pension plan disclosure of plan investments in hedge funds.


January 27, 2009

Mr. CASTLE introduced the following bill; which was referred to the Committee on Education and Labor


To amend title I of the Employee Retirement Income Security Act of 1974 to require in the annual report of each defined benefit pension plan disclosure of plan investments in hedge funds.

Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled,


This Act may be cited as the `Pension Security Act of 2009′.


(a) In General- Section 103(b) of the Employee Retirement Income Security Act of 1974 (29 U.S.C. 1023(b)) is amended–

(1) in paragraph (3)(C), by striking `value;’ and inserting `value, including, in the case of a defined benefit pension plan, a separate schedule identifying each hedge fund (as defined in paragraph 5) in which amounts held for investment under the plan are invested as of the end of the plan year covered by the annual report and the amount so invested in such hedge fund;’; and

(2) by adding at the end the following new paragraph:

`(5) For purposes of paragraph (3)(C), the term `hedge fund’ means an unregistered investment pool permitted under sections 3(c)(1) and 3(c)(7) of the Investment Company Act of 1940 (15 U.S.C. 80a-3(c)(1), (7)) and section 4(2) of the Securities Act of 1933 (15 U.S.C. 77d(2)) and Rule 506 of Regulation D of the Securities and Exchange Commission (17 CFR 230.506).’.

(b) Effective Date; Regulations- The amendments made by subsection (a) shall apply with respect to annual reports for plan years beginning on or after the date of the enactment of this Act. The Secretary of Labor, in consultation with the Securities and Exchange Commission, shall issue initial regulations to carry out the amendments made by subsection (a) not later than 1 year after the date of the enactment of this Act.


Other bills introduced into Congress:

Other hedge fund law articles related to ERISA and hedge funds:

Bart Mallon, Esq. runs hedge fund law blog and has written most all of the articles which appear on this website.  Mr. Mallon’s legal practice is devoted to helping emerging and start up hedge fund managers successfully launch a hedge fund.  If you are a hedge fund manager who is looking to start a hedge fund, please call Mr. Mallon directly at 415-296-8510.

Inspector General’s Madoff Report

SEC’s Madoff Investigation = Stunning Failure

As has been widely reported, the Inspector General has released a 450 page report on the SEC’s stunning failure to uncover the Bernard Madoff Ponzi scheme.  Below I have republished some of the more interesting items from the summary portion of the report (emphasis mine).  While we have heard many of the details before, the description of the “egregious” incompetence is still almost unbelievable.

To access the whole report, please see OIG Madoff Report.  Chairman Shapiro’s comments, reprinted below, can be found here.


Selected sections of the Inspector General’s summary

The OIG investigation did find, however, that the SEC received more than ample information in the form of detailed and substantive complaints over the years to warrant a thorough and comprehensive examination and/or investigation of Bernard Madoff and BMIS for operating a Ponzi scheme, and that despite three examinations and two investigations being conducted, a thorough and competent investigation or examination was never performed. The OIG found that between June 1992 and December 2008 when Madoff confessed, the SEC received six [arguably 8] substantive complaints that raised significant red flags concerning Madoff’s hedge fund operations and should have led to questions about whether Madoff was actually engaged in trading. Finally, the SEC was also aware of two articles regarding Madoff’s investment operations that appeared in reputable publications in 2001 and questioned Madoff’s unusually consistent returns.


One effort was made to verify Madoff’s trading with an independent third-party, but even after they received a very suspicious response, there was no follow-up. The Assistant Director sent a document request to a financial institution that Madoff claimed he used to clear his trades, requesting records for trading done by or on behalf of particular Madoff feeder funds during a specific time period. Shortly thereafter, the financial institution responded, stating there was no transaction activity in Madoff’s account for that period. Yet, the response did not raise a red flag for the Assistant Director, who merely assumed that Madoff must have “executed trades through the foreign broker-dealer.” The examiners did not recall ever being shown the response from the financial institution, and no further follow-up actions were taken.


At a crucial point in their investigation, the Enforcement staff was informed by a senior-level official from the NASD that they were not sufficiently prepared to take Madoff’s testimony, but they ignored his advice. On May 17, 2006, two days before they were scheduled to take Madoff’s testimony, the Enforcement staff attorney contacted the Vice President and Deputy Director of the NASD Amex Regulation Division to discuss Madoff’s options trading. The NASD official told the OIG that he answered “extremely basic questions” from the Enforcement staff about options trading. He also testified that, by the end of the call, he felt the Enforcement staff did not understand enough about the subject matter to take Madoff’s testimony. The NASD official also recalled telling the Enforcement staff that they “needed to do a little bit more homework before they were ready to talk to [Madoff],” but that they were intent on taking Madoff’s testimony as scheduled. He testified that when he and a colleague who was also on the call hung up, “we were both, sort of, shaking our heads, saying that, you know, it really seemed like some of these [options trading] strategies were over their heads.” Notwithstanding the advice, the Enforcement staff did not postpone Madoff’s testimony.


During his testimony, Madoff also told the Enforcement investigators that the trades for all of his advisory accounts were cleared through his account at DTC. He testified further that his advisory account positions were segregated at DTC and gave the Enforcement staff his DTC account number. During an interview with the OIG, Madoff stated that he had thought he was caught after his testimony about the DTC account, noting that when they asked for the DTC account number, “I thought it was the end game, over. Monday morning they’ll call DTC and this will be over . . . and it never happened.” Madoff further said that when Enforcement did not follow up with DTC, he “was astonished.”

This was perhaps the most egregious failure in the Enforcement investigation of Madoff; that they never verified Madoff’s purported trading with any independent third parties. As a senior-level SEC examiner noted, “clearly if someone … has a Ponzi and, they’re stealing money, they’re not going to hesitate to lie or create records” and, consequently, the “only way to verify” whether the alleged Ponzi operator is actually trading would be to obtain “some independent third-party verification” like “DTC.”

A simple inquiry to one of several third parties could have immediately revealed the fact that Madoff was not trading in the volume he was claiming.


The OIG summary concludes that:

As the foregoing demonstrates, despite numerous credible and detailed complaints, the SEC never properly examined or investigated Madoff’s trading and never took the necessary, but basic, steps to determine if Madoff was operating a Ponzi scheme. Had these efforts been made with appropriate follow-up at any time beginning in June of 1992 until December 2008, the SEC could have uncovered the Ponzi scheme well before Madoff confessed.

The OIG’s matter of fact concluding statement that “the SEC could have uncovered” the fraud rings hollow, especially for the people who lost life savings needlessly.


Chairman Shapiro’s Statement

Statement by SEC Chairman:
Statement on the Inspector General’s Report Regarding the Bernard Madoff Fraud
Chairman Mary L. Schapiro
U.S. Securities and Exchange Commission
Washington, D.C.
September 4, 2009

Today we are releasing the Inspector General’s 450-page report regarding the Bernard Madoff fraud and the many missed opportunities to discover it.

As I stated earlier this week, it is a failure that we continue to regret, and one that has led us to reform in many ways how we regulate markets and protect investors.

In the coming weeks we will continue to closely review the full report and learn every lesson we can to help build upon the many reforms we have already put into place since January.

# # #

A list of the SEC’s many reforms undertaken is available at

The Inspector General’s report is available at

SEC Chairman Schapiro’s September 2 statement is available at


Other Hedge Fund Law Blog related to the Madoff scandal:

Securitizing Life Settlement Investments

New Investment Opportunities for Hedge Funds

A recent New York Times article discusses how some investment banks are planning to securitize life settlement policies.  The article explains that there is likely to be a strong demand for such securities.  Much like the securitization of mortgages, life settlement securities would have different tranches which would have different risk profiles.

We have talked earlier about the definition of life settlements and about life settlement hedge funds.  Over the past couple of months I have talked with a number of people involved in this aspect of the alternative investment industry and it seems to continue to be quite a lively little niche.  I believe that if these investments are securitized, this new asset class will be attractive for some hedge fund managers – either as a central investment program or as a compliment to their current hedge fund investment program.

It will be interesting to see how this plays out and how the SEC and various states will react.


Other articles related to hedge funds and life settlements include:

Bart Mallon, Esq. runs hedge fund law blog and has written most all of the articles which appear on this website.  Mr. Mallon’s legal practice is devoted to helping emerging and start up hedge fund managers successfully launch a hedge fund.  If you are a hedge fund manager who is looking to start a hedge fund (including a fund focused on life settlement investments or premium finance), please call Mr. Mallon directly at 415-296-8510.

Investment Advisory Fees | Hedge Fund Performance Fees and Management Fees

Review of State Investment Advisory Fee Rules

One of the things I have tried to emphasize within this blog is that there is no “one size fits all” legal solution to hedge fund formation.  Each client/manager has a unique set of circumstances and will be subject to a potentially different sets of laws or regulations depending on those circumstances.  This is especially true with regard to those managers who must register in a state that requires hedge fund manager registration.  Because no two sets of state laws and regulations are the same, the manager must make sure that he understands the rules which are specific to his state.

High Asset Management Fees and Disclosure

One issue which comes up every now and again is whether or not disclosure will be required when the manager charges an annual asset management fee in excess of 3% of AUM.  Generally regulators will require that certain disclosures be made to investors through the manager’s disclosure documents (generally in both the Form ADV and the hedge fund offering documents).  Sometimes the regulator will require such disclosures based on a general provision (see CO IA fee rule discussion below) or on more explicit provisions (see 116.13(a) of the Texas Administrative Code).  In either case managers will generally be required to make a prominent disclosure to investors that a 3% (or higher) annual asset management fee is in excess of industry norms and that similar advisory services may be obtained for less (whether or not this is true).  While such a disclosure would, in most instances, be a best practice, managers should be aware that it may also be required if they are registered with a particular state.

State Performance Fee Rules

Like management fee disclosures, the rules for performance fees may differ based on the state of registration.  For example, here are how four different states deal with performance fee issue:

Texas – Like most states, Texas allows state-registered investment advisers to charge performance fees only to those investors in a fund which are “qualified clients” as defined in Rule 205-3 of the Investment Advisers Act. This means that a hedge fund manager can only charge performance fees to investors in the fund which have a $1.5 million net worth or who have $750,000 of AUM with the manager (can be in the fund and through other accounts).  See generally  116.13(b) of the Texas Administrative Code reprinted below.

New Jersey – Many states adopted laws and regulations based on the 1956 version of the Uniform Securities Act and have yet to make the most recent update to their laws and regulations (generally those found in the 2002 version of the Uniform Securities Act).  Under the New Jersey laws a manager can charge performance fees to those clients with a $1 million net worth.

Indiana – similar to New Jersey, Indiana has laws which allow a manager to charge performance fees to those investors with a $1 million  net worth.  Additionally, Indiana allows a manager to charge performance fees or to those investors who have $500,000 of AUM with the manager (can be in the hedge fund and through other separately managed accounts).  Indiana also has an interesting provision which specifies the manner in which the performance fee may be calculated – it requires that the fee be charged on a period of no less than one year.  This rule is based on an earlier version of SEC Rule 205-3.  What this means, essentially, is that managers who are registered in Indiana cannot charge quarterly performance fees, but must charge their performance fees only on an annual basis (or longer).

Michigan – Unlike any other state, Michigan actually forbids all performance fees for Michigan-registered investment advisors.  The present statute is probably an unintended consequence of some sloppy drafting.  Nonetheless, it is a regulation on the books.  Hedge Fund Managers registered with Michigan, however, should see the bright spot – Michigan is in the process of updating its securities laws and regulations.  This means that sometime in late 2009 or early 2010 it should be legal for investment advisors in Michigan to charge their clients a performance fee under certain circumstances (likely to mirror the SEC rules).

New York – Sometimes, states will have some wacky rules.  In the case of New York, there are no rules regarding performance fees.

Other Issues

With regard to performance fees, the other issue which should be discussed with your hedge fund lawyer is whether or not the state “looks through” to the underlying investor to determine “qualified client” status.  Generally most states will follow the SEC rule on this issue and look through the fund to the underlying investors to make this determination.

While these cases are just a couple of examples of the disparate treatment of similarly situated managers, they serve as a reminder that investment advisor (and securities) laws may differ wildly from jurisdiction to jurisdiction.  Managers should be aware of the possibility of completely different laws and should be ready to discuss the issue with legal counsel.

The various rules discussed above have been reprinted below.


Texas Rule

The full text of the Texas IA fee rules can be found here and are copied below.

§116.13.Advisory Fee Requirements.

(a) Any registered investment adviser who wishes to charge 3.0% or greater of the assets under management must disclose that such fee is in excess of the industry norm and that similar advisory services can be obtained for less.

(b) Any registered investment adviser who wishes to charge a fee based on a share of the capital gains or the capital appreciation of the funds or any portion of the funds of a client must comply with SEC Rule 205-3 (17 Code of Federal Regulations §275.205-3), which prohibits the use of such fee unless the client is a “qualified client.” In general, a qualified client may include:

(1) a natural person or company who at the time of entering into such agreement has at least $750,000 under the management of the investment adviser;

(2) a natural person or company who the adviser reasonably believes at the time of entering into the contract:  (A) has a net worth of jointly with his or her spouse of more than $1,500,000; or (B) is a qualified purchaser as defined in the Investment Company Act of 1940, §2(a)(51)(A) (15 U.S.C. 80a-2(51)(A)); or

(3) a natural person who at the time of entering into the contract is: (A) An executive officer, director, trustee, general partner, or person serving in similar capacity of the investment adviser; or (B) An employee of the investment adviser (other than an employee performing solely clerical, secretarial, or administrative functions with regard to the investment adviser), who, in connection with his or her regular functions or duties, participates in the investment activities of such investment adviser, provided that such employee has been performing such functions and duties for or on behalf of the investment adviser, or substantially similar function or duties for or on behalf of another company for at least 12 months.

CO Rule

The full text of the Colorado laws and regulations can be found here.  The fee discussion is reprinted below.

51-4.8(IA) Dishonest and Unethical Conduct


A person who is an investment adviser or an investment adviser representative is a fiduciary and has a duty to act primarily for the benefit of its clients. While the extent and nature of this duty varies according to the nature of the relationship between an investment adviser and its clients and the circumstances of each case, an investment adviser or investment adviser representative shall not engage in dishonest or unethical conduct including the following:

J. Charging a client an advisory fee that is unreasonable in light of the type of services to be provided, the experience of the adviser, the sophistication and bargaining power of the client, and whether the adviser has disclosed that lower fees for comparable services may be available from other sources.

New Jersey

The full text of the New Jersey performance fee rules can be found here and are copied below.

13:47A-2.10 Performance fee compensation

(b) The client entering into the contract subject to this regulation must be a natural person or a company as defined in Rule 205-3, who the registered investment advisor (and any person acting on the investment advisor’s behalf) entering into the contract reasonably believes, immediately prior to entering into the contract, is a natural person or a company as defined in Rule 205-3, whose net worth at the time the contract is entered into exceeds $1,000,000. The net worth of a natural person shall be as defined by Rule 205-3 of the Investment Advisors Act of 1940.


The Indiana rule can be found here and is reprinted below.

(f) The client entering into the contract must be either of the following:

(1) A natural person or a company who immediately after entering into the contract has at least five hundred thousand dollars ($500,000) under the management of the investment adviser.

(2) A person who the investment adviser and its investment adviser representatives reasonably believe, immediately before entering into the contract, is a natural person or a company whose net worth, at the time the contract is entered into, exceeds one million dollars ($1,000,000). The net worth of a natural person may include assets held jointly with that person’s spouse.


The current law (until October 1, 2009) can be found here and is copied below.

451.502 Investment adviser; unlawful practices.

(b) It is unlawful for any investment adviser to enter into, extend, or renew any investment advisory contract unless it provides in writing all of the following:

(1) That the investment adviser shall not be compensated on the basis of a share of capital gains upon or capital appreciation of the funds or any portion of the funds of the client.

New York

No laws regarding performance fees for state registered investment advisers.


Please contact us if you have any questions or would like to start a hedge fund. Other related hedge fund law articles include:

Bart Mallon, Esq. runs hedge fund law blog and has written most all of the articles which appear on this website.  Mr. Mallon’s legal practice, Cole-Frieman & Mallon LLP, is devoted to helping emerging and start up hedge fund managers successfully launch a hedge fund.  If you are a hedge fund manager who is looking to start a hedge fund, please call Mr. Mallon directly at 415-296-8510.

Hedge Funds and TV Tokyo

One of the interesting aspects about having a hedge fund blog is that it provides me with the opportunity to connect with many people in the hedge fund industry whom I would normally not have a chance to meet.  I also have the opportunity to talk with various media publications regarding hedge funds.  The two inquiries below come from TV Tokyo who is spotlighting the Lehman crises and doing a report on how hedge funds are currently fairing.  I have received two inquiries now, so if you are interested in talking with them, I am happy to pass along the appropriate contact information.

Any other media organizations who wish to discuss hedge funds or the legal and regulatory aspects of hedge funds are welcome to contact me directly to discuss.


Hi, I’m from TV Tokyo, Japanese TV production. I’m working on the story about what is going on hedge fund industory after Lehman crises. For our segment,  I’m looking for the indivisual investor who put their money into hedge fund due to due to improved transparency and liquidity terms.and I would like to ask the investor to have our taped interview in next week. If you know someone, please let me know. Thank you so much for taking your time to read this message.


Dear Bart,

I am a producer at TV Tokyo, a Japanese television network. I am producing a documentary about recovery in financial institutions and markets.  Over the past year or two, markets plunged and many financial institutions, including hedge funds, were bankrupted or merged out of existence.  In a relatively brief time, however, certain markets and financial institutions demonstrated surprising resilience and a return to profitability. This recovery is in marked contrast to the decade long process of recovery in Japan.

In the documentary, I will focus on how financial institutions, markets and exchanges have managed to again make profits in such short period. Among markets, I will focus on the commodity market, which has benefitted from economic expansion in emerging markets and concerns about inflation elsewhere.  As part of that examination, I would also like to feature the IntercontinentalExchange (ICE). Much of the volume in recent commodities trading has occurred on ICE, however, many of our viewers are unfamiliar with it.

I am seeking individuals to interview for the documentary who can speak authoritatively about the above topics.  If you can address these topics on camera, please contact me.

My deadline for filming is the end of August/beginning of September.
I look forward to your reply.



About TV Tokyo:
TV Tokyo is one of Japan’s six television networks and is a subsidiary of Nihon Keizai Shimbun (Nikkei), Japan’s premier financial journal. We produce Japan’s only daily business and economic news programs, World Business Satellite and News Morning Satellite. Their combined audience averages 5-6 million viewers daily, including Japanese business leaders and influential politicians. A recent study showed our audience to be the most affluent and highly educated in Japan. Past guests include: Prime Minister Yasuo Fukuda; Former Harvard University president Lawrence Summers; professors Joseph Stiglitz (Nobel laureate), Jeffrey Sachs, and Alan Blinder; CEOs Michael Eisner, Steve Forbes, Bill Gates, Steve Ballmer, Jack Welch, Jeffrey Immelt, Larry Ellison, Scott McNealy; investor Jim Rogers, George Soros, Warren Buffett and numerous Japanese business and political leaders.


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