Hartley Bernstein, a New-York securities lawyer and founder of securities watchdog website, StockPatrol.com, is asking - "Is the sky really falling?." "Or," as Mr. Bernstein notes, "is a lone bird circling overhead, dropping nasty messages on our heads?"
Mr. Bernstein's questions come in the wake of concerns about the fate of two Bear Stearns hedge funds and the implications that their tenuous standing may have on the broader market. In a commentary on StockPatrol.com, Mr. Bernstein wonders whether a pending crisis in the capital markets has been "averted, postponed, or fatally ignored as we whistle past the investment graveyard." As is usually the case on Wall Street, investor sentiment, and a nervous marketplace are likely to play a key role in the course of this predicament.
Hartley Bernstein points to a recent Wall Street Journal article, which pointed out that risky hedge funds have become heavily weighted with illiquid investments. "In part," Bernstein explains, "this has allowed hedge fund managers to value fund assets aggressively - using high-water marks for risky instruments and esoteric holdings." This in turn can benefit the portfolio managers to the extent their compensation is keyed to fund value. "But are some asset appraisals illusory and, if so, will funds eventually be called upon to answer for arbitrary valuations and possible conflicts of interest?," Mr. Bernstein wonders.
As the StockPatrol.com article points out, "hedge fund lenders could hold the key to this Pandora’s Box." Again, as the Wall Street Journal notes, when leveraged investments begin to suffer substantial losses, a fund’s lenders may demand more collateral or seek repayment of outstanding loans. Funds that invested heavily in complex securities backed by failing sub-prime mortgages are feeling pressure from lenders.
Mr. Bernstein expressed concern over potential effect of hedge fund failures on smaller investors. "It would be easy to dismiss the potential losses as just one more foreseeable risk assumed by sophisticated hedge fund investors," Mr. Bernstein stated, but "unfortunately, repercussions are seldom so simple and victims are never that discrete. With cash flowing freely in recent years, a broad range of investors have jumped into hedge funds and their promise of even greater riches." The Wall Street Journal recently reported that institutional investors, including pension funds and endowments have increased their investments in hedge funds and other less liquid instruments. As StockPatrol.com noted, "Individual beneficiaries of those institutions may have little notion that their personal worth is tied to illiquid investments that could range from imaginative packages of risky real estate to timberlands. Or that a flash fire of creditor panic could jeopardize the value of their holdings."
Bernstein warns that small investors may find themselves at loggerheads with hedge fund managers - and with institutional portfolio managers as well - if these risky investments were not suitable in the first place. A rash of lawsuits from investors can be expected as losses mount.
And Bernstein wonders, "Should we have seen it coming – as we looked up in the sky at the bird hovering overhead? Would investors be sufficiently forewarned if they if a fund were named “The Highly-Speculative, Riskiest Possible, Kiss Your Money Goodbye, You Need To Be Out of Your Mind to Invest” fund? Or like the cartoon Roadrunner and Coyote would they continue to race past the sign that says “Danger Ahead. Road Ends Here” and jump off the cliff?"
Hartley Bernstein is a New York attorney whose practice includes representation of investors who have been victimized by corporate fraud, improper investment practices and stock scams. Mr. Bernstein is also the Founder and Publisher of StockPatrol.com, which is widely-recognized as a leading watchdog for investors.
