2. “Frequently we are told that this regulation has been throttling the country's prosperity. Bitterly hostile was Wall Street to the enactment of the regulatory legislation. It now looks forward to the day when it shall, as it hopes, reassume the reigns of its former power.... The public, however, is sometimes forgetful. As its memory of the unhappy market collapse of 1929 becomes blurred, it may lend at least one ear to the persuasive voices of The Street subtly pleading for a return to the “good old times.” Ferdinand Pecora, Wall Street Under Oath: The Story Of Our Modern Money Changers), Author’s Preface. [1][1] PECORA, id., at 3.

3. The “Good Old Times” Are Back Again I suggest the “good old times” are now back again and the device your Committee designed to protect the public investor--the SEC--needs fixing. The first step in getting a handle on the risks posed by hedge funds is to separate and tag them. I believe there are three risks: (1) hedge fund conduct that cheats their own investors; (2) hedge fund conduct that randomly cheats everybody else, and (3) the systemic risks such as those that surfaced when Long Term Capital Management (“LTCM”) collapsed. May 30, 2006, letter of Gary Aguirre to the U.S. Senate Committee on Banking, Housing and Urban Affairs.

4. How the SEC Learned Hedge Funds Cheat Others; the Mutual Fund Scandal For twenty-five years, from 1979 to 2004, hedge fund fraud and manipulation operated under the SEC’s radar. The SEC brought no cases against hedge funds for manipulation, insider trading, or fraud directed against other market participants. During this period, the SEC recognized only one species of hedge fund fraud: that committed by a hedge fund against its own investors. The SEC first publicly recognized that there were two classes of hedge fund fraud in July 2004. Its proposed rule requiring hedge funds to register noted: “Since the staff report [of September 2003], a new species of hedge fund fraud has been uncovered (emphasis added).” May 30, 2006, letter of Gary Aguirre to the U.S. Senate Committee on Banking, Housing and Urban Affairs, p. 11-12.

5. SEC Proposed Rule for Registration Under the Advisers Act of Certain Hedge Fund Advisers “Since the staff report [of September 2003], a new species of hedge fund fraud has been uncovered. Advisers to hedge funds have been key participants in the recent scandals involving mutual fund late trading and inappropriate market timing.” July 28, 2004

6. Aside from the PIPE cases, the SEC has recovered approximately $110,000 from hedge funds and their principals for all other types of insider trading. How could this be? The explanation is quite simple: the SEC has brought a total of six cases for insider trading against hedge funds. Three of those cases involve a cookie cutter type of insider trading: the violator shorts a public company in advance of an announcement of a Private Investment in Public Entities (PIPE). The SEC’s concentration of its resources on PIPE insider trading cases is curious. The PIPE market is relatively small: $20 billion in 2005. By comparison, the merger and acquisition market was $1.46 trillion over a recent twelve month period. … So why do half the SEC insider trading cases against hedge funds arise out of PIPE transactions? One obvious answer: next slide December 5, 2006, testimony of Gary J. Aguirre before the U.S. Senate Committee on he Judiciary.

7. Low Hanging Fruit

8. “The boom in corporate mergers is creating concern that illicit trading ahead of deal announcements is becoming a systemic problem… “[A]n analysis of the nation’s biggest mergers over the last 12 months indicates that the securities of 41 percent of the companies receiving buyout bids exhibited abnormal and suspicious trading in the days and weeks before those deals became public. For those who bought shares during these periods of unusual trading, quick gains of as much as 40 percent were possible.” August 27, 2006.

9. 12 “GOD-GIVEN MARKETS” Throughout the course of the investigation … no matter what the immediate subject of inquiry … the Stock Exchange was never very far away. Manipulation of the markets was not merely the source of immediate stock-market profit, but the indispensable means to innumerable tortuous schemes and devices. Ferdinand Pecora, Wall Street Under Oath: The Story Of Our Modern Money Changers, at 258.

10. It all looks alike on the ticker “The Public was always in the dark. It could not tell whether sales were due merely to the ‘free play of supply and demand,’ or whether they were the product of manipulated activities…It all looks alike on the ticker (emphasis added).” Ferdinand Pecora, Wall Street Under Oath: The Story Of Our Modern Money Changers, at 267.

13. Yet the participants in the Radio operation were not criminal types of the sort of Yellow Kid Weil and the other celebrated con men. They were, on the contrary, rich and eminent Americans, national leaders whose names were known and honored everywhere. Among them, for example, were Walter P. Chrysler; … Percy A. Rockefeller, nephew of John D; …John J. Raskob, Democratic National Chairman; … John Brooks, Once in Golconda, A True Drama of Wall Street 1920-1938, at 66.

14. THE FIRING OF AN SEC ATTORNEY AND THE INVESTIGATION OF PEQUOT CAPITAL MANAGEMENT II. EXECUTIVE SUMMARY Staff Attorney Gary Aguirre said that his supervisor warned him that it would be difficult to obtain approval for a subpoena of John Mack due to his ‘‘very powerful political connections.’’ Aguirre’s claim is corroborated by internal SEC emails ….. Attorneys for Pequot and Morgan Stanley had direct access to the Director and an Associate Director of the SEC’s Enforcement Division In June 2005, Morgan Stanley’s Board of Directors hired former U.S. Attorney Mary Jo White to determine whether prospective CEO John Mack had any exposure in the Pequot investigation. White contacted Director of Enforcement Linda Thomsen directly, and other Morgan Stanley officials contacted Associate Director Paul Berger. Soon afterward, SEC managers prohibited the staff from asking John Mack about his communications with Arthur Samberg at Pequot. Seeking John Mack’s testimony was a reasonable next step in the investigation.

15. SEC management delayed Mack’s testimony for over a year, until days after the statute of limitations expired. The SEC eventually took Mack’s testimony only after the Senate Committees began investigating and after Aguirre’s allegations became public …” The SEC fired Gary Aguirre after he reported his supervisor’s comments about Mack’s ‘‘political connections,’’ despite positive performance reviews and a merit pay raise. U.S. Senate Final Report, p. 5 C. SEC Investigators Identify a Potential Tipper 5. The SEC Fires its Lead Investigator The evidence suggests that the bar for taking other testimony in the Pequot investigation was considerably lower than it was for Mack. If he were a mid- level trader instead of the head of Morgan Stanley, it seems likely that a subpoena would have issued in short order with little or no interference from Aguirre’s supervisors. Unfortunately, we have received anecdotal reports that the sort of deference Mack received is not uncommon. U.S. Senate Final Report, p. 37.

16. “We also commend the SEC for increased enforcement efforts regarding insider trading, and specifically insider trading by hedge funds, following our investigation. On March 1, 2007, in announcing charges against 14 individuals in a brazen insider trading scheme, Chairman Cox stated: ‘Our action today is one of several that will make it very clear the SEC is targeting hedge fund insider trading as a top priority (emphasis added).’’’ U.S. Senate Final Report, p. 1. “Peter Bresnan, Deputy Director of the SEC’s Division of Enforcement, stated in a CNBC interview on May 11, 2007: ‘Hedge fund managers are under enormous pressure to show profits for their clients.... Not every hedge fund manager can get those kinds of return through legitimate trading.’” U.S. Senate Final Report, p. 2. The key to getting an investor to plunk down $500,000 to $50 million subject to the 2% and 20% hedge fund take: “As long as the performance is up there, in the end the investors do not care about the high fees.” Aguirre May 30, 2006, letter to Senator Hagel

17. Hedge Funds, Leverage, and the Lessons of Long-Term Capital Management Report of The President’s Working Group on Financial Markets Recommendations “Market history indicates that even painful lessons receed from memory with time. Some of the risks of excessive leverage and risk taking can threaten the market as a whole, and even market participants not directly involved in imprudently extending credit can be affected (emphasis added).” “Currently, the scope and timeliness of information made available about the financial activities of hedge funds are limited. Hedge funds should be required to disclose additional, and more up-to-date, information to the public.” “Congress should enact legislation granting any additional authority necessary to achieve these goals.”

18. Counterparty Discipline Chairman Ben S. Bernanke At the Federal Reserve Bank of Atlanta’s 2006 Financial Markets Conference, Sea Island, Georgia May 16, 2006 Hedge Funds and Systemic Risk “The primary mechanism for regulating excessive leverage and other aspects of risk- taking in a market economy is the discipline provided by creditors, counterparties, and investors. In the LTCM episode, unfortunately, market discipline broke down.”

19. “A recent report from the Financial Stability Forum, which comprises representatives of major nations’ financial authorities read: "There has been some erosion in counterparty discipline recently (such as declining initial margins), reflecting the strength of competition for hedge fund business … ” Point Of View: Ex-SEC heads join hedge fund worry chorus Associated Press Financial Wire May 29, 2007.

20. Hedge Funds Systemic Risks to Capital markets These systemic concerns have two dimensions: First is the possibility that the behavior of hedge funds in periods of market stress could amplify rather than mitigate the shock, induce larger moves in asset prices, or cause broader damage to the functioning of markets when it is most important they function well. Second is the possibility that the failure of a major hedge fund or group of funds could significantly damage the viability of a major financial institution, both through direct exposure to the fund and losses resulting from the impact on other market risks to which the institution is exposed. These concerns existed before the events associated with Long-Term Capital Management (LTCM) in 1998, but that episode provided a powerful example of both sets of risks, and how the erosion of counterparty discipline can magnify those risks (emphasis added). November 17, 2004, Timothy F. Geithner, President and Chief Executive Officer of the Federal Reserve Bank of New York.

21. In Goldman, Sachs We Trust “The most notable piece of speculative architecture of the late twenties, and the one by which, more than any other device, the public demand for common stocks was satisfied, was the investment trust or company.” John Kenneth Galbraith, The Great Crash 1929, at p. 46 “The virtue of the investment trust was that it brought about an almost complete divorce of the volume of corporate securities outstanding from the volume of corporate assets in existence. The former could be twice, thrice, or any multiple of the latter.” John Kenneth Galbraith, The Great Crash 1929, at p. 47.