Hedge Funds Learn D.C. Business Rules

Hedge fund managers aren't known as a particularly polite crew. The financial risk addicts raid boardrooms, seize assets and grab up the best real estate.

In Washington, however, they're increasingly playing nice. Their efforts haven't gone unrecognized: Over the past two years, regulators have changed from regarding the secretive industry with caution to giving it minimal oversight.

The transition wasn't stress-free. Hedge fund managers learned the hard way that getting what they wanted in Washington requires checking their aggression at the Beltway.

Hedge funds spent $1.3 million lobbying Congress last year, a 46 percent increase from 2002, according to numbers compiled by the Center for Responsive Politics and Absolute Return magazine, an industry trade publication that tracks the largest hedge funds twice yearly. Hedge fund managers are also giving more to political campaigns; executives at the nation's 30 biggest funds increased their political donations by nearly 17 percent to $14.7 million between 2004 and 2006, the records show.

These amounts are pocket change for an industry managing more than $1.4 trillion in assets. But giving Washington any money at all reflects a major attitude adjustment in the hedge fund world. Traditionally, the industry's government relations strategy was to simply stay home.

Avoidance worked well for many years. Since the first hedge fund was founded in 1949, government regulators have largely left the funds alone. Hedge funds raise money privately and cater to the super-wealthy: Getting into a fund has long required $1 million. Hedge fund managers argued that sophisticated investors didn't need the additional protection of securities laws.

Regulators started paying closer attention to the funds in 2003, when the number and impact of hedge funds increased. The SEC expressed interest in making the funds more transparent by requiring them to register with the agency. Most people in the industry opposed this; in fact, they were reluctant to turn over any information at all. However, their opinions weren't backed with much financial clout; in 2003 and 2004, the Managed Funds Association, the industry's largest trade group, spent just $142,000 on lobbying.

In December 2004, the SEC passed a rule requiring large U.S. hedge funds to register with the agency. The rule not only forced the funds to turn over basic information but allowed the agency to conduct audits. The experience taught hedge fund managers a lesson about the power of politics. They could ignore Washington, but Washington had no intention of ignoring them.

Soon after the SEC's ruling, fund manager George Chanos founded the Coalition of Private Investment Companies to lobby for the industry. "Who's going to paint the picture for D.C. if no one is presenting the facts?" asked Porterfield & Lowenthal's Andrew Lowenthal, the group's Washington-based lobbyist. The group now includes 20 members managing collective assets of about $60 billion.

The MFA also made some changes. The group's roster soared from 600 members to 1,300 members during the past five years. Last year, the association hired well-known business lobbyist Lisa McGreevy from the Financial Services Roundtable to be the chief operating officer. It also started striking a more conciliatory tone, supporting an SEC proposal to increase the amount investors must contribute to a fund from $1 million to $2.5 million.

Today, the MFA often works with Chanos' group; he speaks regularly at association events, and the two groups have sponsored educational seminars on Capitol Hill.

The U.S. Court of Appeals for the D.C. Circuit overturned the SEC registry requirement in June 2006, to the relief of many managers. Still, a small minority support the spirit of the ruling. At least one hedge fund manager publicly embraces more regulation. Kenneth Brody, president of Taconic Capital, supported mandatory regulation for all fundin his March testimony to the House Financial Services committee. While wealthy individuals may not need the extra investor protections, enforcing additional checks on the funds could particularly benefit institutional investors such as pension funds, he said in an interview with The Politico.

Congress may be hearing more of Brody's opinions soon. Last year, he hired the Rich Feuer Group to lobby on behalf of the Ad Hoc Coalition of Hedge Fund Managers. The lobbying firm would not comment on the organization.

Regardless of their legislative stance, all three groups agree that the industry needs an image makeover.

"When Congress doesn't know about something, it creates a level of fear," McGreevy said. But, she added, hedge fund managers aren't monsters lurking under investors' beds. They are normal, hard-working business people, who have billions in their pockets. The lobbying groups regularly arrange meetings for fund managers to teach policymakers, legislators and staffers a crash course in Hedge Fund 101.

Playing in the corridors of the Capitol is decidedly more low-key than on Wall Street. There, hedge funds are infamous for their extravagant parties. Not so in Congress.

"It's Au Bon Pain-style catering," McGreevy said. "We tend to be modest, and it surprises people."

That modest approach seems to be working, even without gourmet meals. At a hearing of the House Financial Services Committee in March, legislators openly admitted that like most of the American public, they don't really understand hedge funds. "It's not quite clear to me what really constitutes a hedge fund," said Rep. Richard Baker (R-La.).

But they also aren't rushing to regulate. A report released in February by the President's Working Group on Financial Markets, which includes SEC Chairman Christopher Cox and Treasury Secretary Henry Paulson, concluded that new hedge fund regulations were not needed. So when Iowa Sen. Charles Grassley, the ranking Republican on the Senate Finance Committee, resuscitated the SEC registration requirement as legislation, lobbyists said it was not likely to go anywhere because Grassley is not on the committee of jurisdiction.

This good regulatory fortune may also be due to the standard Washington turnover. Democratic Sen. Chris Dodd, chairman of the Senate Banking Committee, represents Connecticut, where many funds are based. SAC Capital Advisors, a fund in Stamford, Conn., gave $207,300 to his presidential campaign -- making it his biggest contributor, according to the Center for Responsive Politics. Dodd oversees much of the hedge fund legislation, including Grassley's bill.

The industry also has some powerful friends in the agencies. Treasury Secretary Paulson is a former CEO of Goldman Sachs, which is one of the biggest hedge fund managers in the world. And SEC Chairman Cox appears less focused on hedge funds than his predecessor, William Donaldson.

The former chairman has continued his crusade of the industry; two weeks ago, at an industry roundtable, he described hedge funds and private equity funds as a "ticking time bomb."

It doesn't seem like too many legislators are listening. McGreevy sees that as a powerful lesson for the industry. "You have to come up and tell the hedge fund story," she said. "Congress doesn't like to be fearful of things."