Soros, Falcone Defend Hedge Funds at House Hearing

By Katherine Burton and Lorraine Woellert

Nov. 13 (Bloomberg) -- Hedge-fund managers including George Soros and Philip Falcone, in an unprecedented appearance before Congress, defended their practices and profits while splitting over whether the U.S. should impose stricter regulations.

``This is not a case where management takes huge bonuses or stock options while the company is failing,'' said Falcone, one of five billionaire investors who testified today before the House Committee on Oversight and Government Reform in Washington.

Falcone, senior managing director of New York-based Harbinger Capital Partners, urged Congress to require more disclosure by hedge funds, which oversee $1.7 trillion of investments. Soros, founder of Soros Fund Management LLC, cautioned against ``ill-considered'' rules because this industry is reeling from market losses and client defections.

``We do not need greater regulation of hedge funds,'' said Kenneth Griffin, founder of Citadel Investment Group LLC in Chicago. ``We've not seen hedge funds as a focal point of the carnage.''

The hearing was called by committee Chairman Henry Waxman, whose panel doesn't have jurisdiction over securities-industry legislation. Even so, his interest suggests the industry faces increased scrutiny and regulation next year after President- elect Barack Obama takes office.

Registration Redux

Senator Chuck Grassley, an Iowa Republican, said he would reintroduce legislation to require hedge funds to register with the U.S. Securities and Exchange Commission. In 2006, the D.C. Circuit Court of Appeals overturned an SEC rule requiring registration, saying the agency overstepped its authority.

Soros, Falcone, Griffin were joined by Paulson & Co.'s John Paulson and James Simons, head of Renaissance Technologies LLC, in testifying as part of a congressional investigation into the credit crunch that has pushed major economies to the brink of recession. Selling by hedge funds, many of which are facing client defections, has been a factor in driving financial markets lower.

This year has been the worst on record for hedge funds, with the average fund losing 15.5 percent through October, according to data compiled by Hedge Fund Research Inc. of Chicago. That compared with the 34 percent decline by the Standard & Poor's 500 Index, a benchmark for the biggest U.S. stocks.

Waxman began by questioning the men about whether their industry is a risk to the financial system, an idea they downplayed. The hearing is one of many Democrats are convening to explore the causes of the global financial crisis.

`Unimaginable Success'

Hedge-fund managers have had ``unimaginable success'' and, while being ``virtually unregulated,'' many enjoy special tax breaks, said Waxman, a California Democrat. Today's witnesses, he said, earned on average more than $1 billion last year, profits they were able in many cases to treat as capital gains rather than as ordinary income, which is taxed at a higher rate.

``I gotta tell you, that is a staggering amount of money,'' said Representative Elijah Cummings, a Maryland Democrat. ``You are not taxed like ordinary citizens.''

The investors urged lawmakers not to change tax rules for hedge funds without changing them for all long-term investors.

Falcone said that 98 percent of his income was taxed as ordinary income. He along with Soros and Simons said they would agree to higher taxes on long-term gains.

Paulson and Griffin were more reluctant.

``I believe our tax situation is fair,'' Paulson said. ``If your constituents, whether a plumber or a teacher, bought a stock and if they held that stock for more than a year they would pay a long-term capital gains rate.''

Waxman and Representative Thomas Davis of Virginia, the panel's top Republican, suggested the need for more oversight of the industry.

Main Street Impact

``This isn't just about sophisticated, high-stakes investors anymore,'' Davis said. ``Institutional funds and public pensions now have a huge stake in hedge funds' promises of steady, above-market returns. That means public employees and middle-income senior citizens, not just Tom Wolfe's Masters of the Universe, lose money when hedge funds decline or collapse.''

Falcone, 46, said he supported more public disclosure and transparency. Investors ``have a right to know what assets companies have an interest in -- whether on or off their balance sheets -- and what those assets are really worth,'' he said.

Fed Disclosure

Soros warned the committee against ``going overboard with regulation'' now that ``the bubble has now burst and hedge funds will be decimated. I would guess that the amount of money they manage will shrink by between 50 and 75 percent. It would be a grave mistake to add to the forced liquidation currently dislocating markets by ill-considered or punitive regulations.''

Simons suggested that hedge funds' positions be disclosed to regulators and made available to the Federal Reserve Bank of New York, though not made public.

The hedge-fund managers also defended their multimillion- dollar compensation, saying they earned money only when their investors did.

``In our business, one of the most fundamental principles is alignment of our interests with those of our clients,'' said Paulson, who takes 20 percent of any gains. ``All of our funds have a 'high-water mark,' which means that if we lose money for our investors, we have to earn it back before we share in future profits.''

Soros, best known for making $1 billion betting against the British pound, is the chairman of the $19 billion Soros Fund Management in New York. He has called credit-default swaps the next crisis area because the market is unregulated, and he has recommended the creation of an exchange where these contracts could be traded, a move seconded by Griffin.

Falcone Reversal

Paulson, 52, runs a New York-based fund that manages about $36 billion. His Credit Opportunities Fund soared almost sixfold in 2007, primarily on wagers that subprime mortgages would tumble. Paulson's Advantage Plus fund has climbed 29 percent this year through October while many managers are enduring the worst year of their careers.

Falcone also profited from a drop in subprime mortgages last year, when his fund, now about $20 billion, doubled. This year the fund was up 42 percent at the end of June and has since tumbled to a loss of about 13 percent. He told the panel that his father, a utility superintendent, never made more than $14,000 a year, and his mother worked in a local shirt factory.

Simons, 70, runs his $29 billion fund out of East Setauket, New York. The former academic makes money by using computer models to trade. His Medallion Fund, made up of his own money and that of his employees, is up more than 50 percent this year.

Griffin, 40, runs the $16 billion Citadel Investment Group LLC in Chicago, and has faced the toughest year out of the five billionaire managers. His funds dropped 38 percent this year through Nov. 4.

To contact the reporters on this story: Katherine Burton in New York at kburton@bloomberg.net; Lorraine Woellert in Washington at lwoellert@bloomberg.net.