Top hedge funds see more rules coming

WASHINGTON/BOSTON (Reuters) - Some of the world's richest hedge fund managers conceded on Thursday that their secretive investment industry would have to disclose more information to satisfy financial regulators.

In a rare appearance before lawmakers on Thursday, George Soros, James Simons, John Paulson, Philip Falcone and Kenneth Griffin were quizzed about the $1.7 trillion (1.1 trillion pound) industry's use of borrowed money, the taxes they pay and their desire to keep their investments secret.

Rep. Henry Waxman, a California Democrat who heads the House Committee on Oversight and Government Reform, called the hearing at a time when hedge funds have been criticized for accelerating the worst financial crisis since the Depression.

"Currently, hedge funds are virtually unregulated," Waxman said. "They are not required to report information on their holdings, their leverage, or their strategies. Regulators aren't even certain how many hedge funds exist or how much money they control."

Hedge funds, which are delivering their worst-ever returns this year, have been blamed for contributing to the collapse of two major investment banks, Bear Stearns and Lehman Brothers, and for having kicked stock prices lower in recent weeks.

George Soros, a Democrat who left retirement at age 78 to resume running Soros Fund Management, said hedge funds played a role in the financial crisis and will suffer the consequences.

"The bubble has now burst and hedge funds will be decimated," said Soros, who earned $1 billion by betting against the British pound in 1992. "I would guess that the amount of money they manage will shrink by between 50 and 75 percent."

Soros offered a bleak outlook for the global economy.

"A deep recession is now inevitable and the possibility of a depression cannot be ruled out," he said.

MORE DISCLOSURE AHEAD

Several fund executives, when questioned by lawmakers, acknowledged hedge funds could pose systemic risks to the financial system. But they also said Lehman and banks that used too much leverage played a big role in the crisis and urged regulators to tighten rules there.

Speaking about themselves, some agreed that regulators should be given greater insight into how they make money.

Soros said "yes," Simons said "yup" and Falcone, who runs Harbinger Capital, added "I agree," when lawmakers asked the panel if U.S. regulators should be able to look closely at their trading positions to prevent an unraveling of the whole financial system.

But any trading data should stay with regulators and not surface in the news media, said Simons, a former mathematics professor who now runs Renaissance Technologies.

Kenneth Griffin, who has run Citadel Investment Group for 18 years, was generally opposed to new regulations. "We do not need greater regulation of hedge funds. We've not seen hedge funds as a focal point of the carnage," he said.

David Ruder, a former chairman of the Securities and Exchange Commission which in recent years tried and failed to force hedge funds to register with the agency, said the credit crisis was mostly due to mortgage originators, investment banks, rating agencies and sellers of credit default swaps

(CDS.L).

"Although hedge funds have been active participants in the financial markets during the past years, they do not seem to have played a major role in the events precipitating the crisis," Ruder testified. He led the SEC during the Reagan administration and is now a Northwestern University professor.

The SEC and the Federal Reserve must share some of the blame for their hands-off approach to highly leveraged banks and the uncontrolled nature of the CDS market, Falcone said.

Falcone also defended short-selling, saying it was a valuable component of financial markets and didn't drive companies out of business. Two months ago, the SEC briefly forbid money managers from shorting some 1,000 financial stocks, or betting the stock price would decline.

Hedge funds are now facing heavy losses and investors demanding their money back. The average hedge fund has lost 15 percent this year, according to Hedge Fund Research.

However, Paulson, one of the first investors to bet housing prices could decline on a national basis last year, is making money this year, even as some of the others who testified are nursing losses.

TAX ISSUE

The five hedge fund managers, on average, made over $1 billion each in 2007, according to Waxman.

Long-term gains by hedge fund managers are taxed at the 15 percent capital gains rate, raising issues of fairness for some lawmakers.

"A schoolteacher or a plumber or a policeman makes on the average of $40,000 or $50,000 a year. Yet they had to pay 25 percent tax," said Rep. Elijah Cummings, a Maryland Democrat.

Asked if they would support having their "carried interest" income taxed at regular rates, Soros said "I have no problem with it" and Simons said "that would be OK with me."

Falcone, who emphasized his humble upbringing in opening testimony, said about 98 percent of his 2007 income was taxed as ordinary income but said hedge funds are not treated any differently than the rest of the investment community.

Paulson also denied there was a tax loophole.

Griffin agreed, saying society prefers long-term capital gains from a tax perspective and there should be consistency, whether involving a hedge fund manager, a private equity manager, or an entrepreneur who starts a restaurant.

(Reporting by Svea Herbst-Bayliss and John Poirier; writing by Karey Wutkowski; Editing by Tim Dobbyn)