Machiavelli
January 14th 2007, 08:49 PM
The hedge fund industry is now a $1.3 trillion global industry. These entities are heavily involved in the equity markets, gov't securities mkts, currency speculation, and derivatives (like options contracts). They have NO transparency requirements, which opens the door for market manipulation. Here's a theory I worked up to illustrate a hypothetical manipulation scheme:
Say you have a publicly traded company (hereafter ACME, Inc.), which is heavily dependent on exporting its products from its host nation to say the US. Then imagine the company is located in a country with a small money supply (this would include most currencies except the dollar & Euro, and perhaps the Yuan & Yen). Buying or selling a few hundred billion dollars (or perhaps less) worth of currency or bonds from that country (hereafter country X) would move its currency valuation & impact the the stock price of ACME, Inc.
It has this effect because changes in the value of country X's currency versus the dollar will result in more or less profits and sales for ACME. If its currency rises against the dollar it will sell less products to the US because its products will be more expensive to its US buyers. If country X's currency weakens in relation to the dollar the opposite will occur.
If a group of hedge funds who control most hedge fund & private equity firm activity collude and invest in an option contract on ACME, betting that its stock price will go down a certain amount say in 90 days, they could buy a bunch of country X's securities toward the end of the contract and ACME's stock would sink & the hedge funds would earn a windfall. The same theory applies to energy contracts, commodity contracts, etc.
The real problem here is the small investor betting ACME's price will go up, because all publicly available information indicates is should go up (the prospectus indicate a good debt to asset ratio, substantial cash on hand, its products are still in their growth cycles, and they have excellent management). The small investor gets ripped off, yet the hedge fund never actually violated any laws. Remember, there's three parties to any option contract. The buyer of a call option, a put option, and the firm underwriting the agreement. You can't call it insider trading because they don't need inside information on ACME for their scheme to work.
All the focus on hedge fund regulation proposals is to protect their investors, when it should be to provide a more perfect and transparent marketplace for all investors. Frankly, a guy working at a hedge fund could tell his day trading buddy what's going on at his hedge fund & his buddy could make millions, without any laws being violated (except the hedge fund employee would probably be breaching his employment agreement & could get fired if busted by his bosses).
I know this is an over-simplification, but I think it's illustrative of the potential for fraud inherent when you allow one third of all trading activity to go on unregulated with no transparency requirements.
Say you have a publicly traded company (hereafter ACME, Inc.), which is heavily dependent on exporting its products from its host nation to say the US. Then imagine the company is located in a country with a small money supply (this would include most currencies except the dollar & Euro, and perhaps the Yuan & Yen). Buying or selling a few hundred billion dollars (or perhaps less) worth of currency or bonds from that country (hereafter country X) would move its currency valuation & impact the the stock price of ACME, Inc.
It has this effect because changes in the value of country X's currency versus the dollar will result in more or less profits and sales for ACME. If its currency rises against the dollar it will sell less products to the US because its products will be more expensive to its US buyers. If country X's currency weakens in relation to the dollar the opposite will occur.
If a group of hedge funds who control most hedge fund & private equity firm activity collude and invest in an option contract on ACME, betting that its stock price will go down a certain amount say in 90 days, they could buy a bunch of country X's securities toward the end of the contract and ACME's stock would sink & the hedge funds would earn a windfall. The same theory applies to energy contracts, commodity contracts, etc.
The real problem here is the small investor betting ACME's price will go up, because all publicly available information indicates is should go up (the prospectus indicate a good debt to asset ratio, substantial cash on hand, its products are still in their growth cycles, and they have excellent management). The small investor gets ripped off, yet the hedge fund never actually violated any laws. Remember, there's three parties to any option contract. The buyer of a call option, a put option, and the firm underwriting the agreement. You can't call it insider trading because they don't need inside information on ACME for their scheme to work.
All the focus on hedge fund regulation proposals is to protect their investors, when it should be to provide a more perfect and transparent marketplace for all investors. Frankly, a guy working at a hedge fund could tell his day trading buddy what's going on at his hedge fund & his buddy could make millions, without any laws being violated (except the hedge fund employee would probably be breaching his employment agreement & could get fired if busted by his bosses).
I know this is an over-simplification, but I think it's illustrative of the potential for fraud inherent when you allow one third of all trading activity to go on unregulated with no transparency requirements.