Aguirre Discusses Byrne, Naked Shorting & Bigger Pictures
By Christopher Faille, Senior Financial Correspondent
Tuesday, August 14, 2007
SAN DIEGO (HedgeWorld.com)âGary Aguirre, at the center of a regulatory storm that has now swirled about Washington for two years, said he looks for the big picture from his California home.
In an exclusive interview with HedgeWorld on Tuesday [Aug. 14], Mr. Aguirreâwho was fired from the Securities and Exchange Commission in 2005, and who has since alleged that his firing was the result of his persistence in investigating suspect trades by hedge fund Pequot Capital Previous HedgeWorld Storyâboth embraced and distanced himself from the anti-naked shorting crusade of Overstock.com Chief Executive Patrick Byrne and others.
There are three categories of risk with hedge funds, Mr. Aguirre said. The first category is the fact that hedge funds sometimes cheat their investors. This is the least serious of the three categories, since their investors generally are capable of looking after themselves, and Mr. Aguirre said he considers it unfortunate that this is the one threat on which the SEC spends the most time.
The second risk category is that hedge funds may victimize other market participants, many of whom are unaware of what is going on. "There are at least a half a dozen different ways of doing this," he said Tuesday. Naked shorting is one of those ways. Insider trading, on the long side, the short side or both, is another. Market timing through compliant mutual funds is yet another.
He said that he isn't opposed to short selling as a strategy. "Short selling in general is obviously a market check to excesses on the upside," he said. "But naked shorting is different, because it goes beyond what is available at the investment banks, and there is no limit to it."
He said that he hasn't been in communication with Mr. Byrne, who cited him favorably in a manifesto posted on an Overstock.com Inc. bulletin board last week Previous HedgeWorld Story. The two men have developed their views separately, and so it's unsurprising that they have different emphases, and some area of overlap.
"I agree with Mr. Byrne," Mr. Aguirre said, "that the SEC has failed to protect the capital markets from naked shorting. From my perspective, however, naked shorting is just one of the tactics, and perhaps not the most significant, that hedge funds have used to create a tilted playing field. At some point, the erosion of investor confidence may reach a point that we experience a full blown market collapse."
Mr. Aguirre said, though, that in its level of seriousness, this sort of thingâthe victimization of third parties by hedge fund managers for the benefit of their investorsâis still not a systemic risk.
The third categoryâand the gravest of the three risk categories Mr. Aguirre citedâis the systemic risk that hedge funds pose to the capital markets as such from their unlimited use of leverage.
The combination of those second and third categories, he said, "delivered the 1929 crash and could do so again."
Mr. Aguirre said he is concerned that regulators have fallen into a false sense of security under the influence of the idea that private sector counterparties are effectively constraining hedge funds. "I've done a little research into this idea of counterparty constraint and I don't think it has any substance." It didn't work before, not in 1929, when unregulated pools of money then called syndicates or pools helped create the conditions for crash and depression, and not in 1998, when the counterparties of Long-Term Capital Management required the good offices of the Federal Reserve. And it isn't working now, Mr. Aguirre said.
There is such a "tremendous cash flow from hedge funds to investment banks" in the latter's capacity as prime brokers, Mr. Aguirre said, that it is unrealistic to expect the investment banks to act as a check upon hedge funds.
Furthermore, there's been a good deal of blurring of the lines between investment banks and hedge funds. "Until the last couple of months, we've seen a near hysteria in investment banks that you've got to own your own hedge fund," Mr. Aguirre said.
After the LTCM incident, Mr. Aguirre said, the President's Working Group on Financial Markets recommended greater transparency for hedge funds. "I don't know whether that would have been enough," Mr. Aguirre said, "but it would have been something." Unfortunately, from his perspective, hedge funds remain opaque, and regulators continue to rely too much upon counterparties to mitigate the risks posed by hedge funds.
CFaille@HedgeWorld.com