Hedge fund traders seek wealthy investors, but keep low profile

BOULDER — A cadre of Boulder money managers are using hedge fund trading strategies to quietly accumulate wealth for their clients.

Hedge fund traders typically don’t want to draw attention to themselves. That’s because

a federal securities law, called Regulation D, sets several rules that exempt sales of certain securities from Securities Act registration.

SPONSORED CONTENT

Empowering communities

Rocky Mountain Health Plans (RMHP), part of the UnitedHealthcare family, has pledged its commitment to uplift these communities through substantial investments in organizations addressing the distinct needs of our communities.

Under Rule 505, for example, which exempts sales of securities totaling up to $5 million in any 12-month period, the seller cannot use “general solicitation or advertising to sell the securities.”

Hedge fund traders also prefer to work only with “qualified” investors — those with about $1 million in net worth, says Joel Ehrlich, who co-owns The Boulder Hedgehogs LLC with partner Stan Wolpoff.

“You can’t really advertise that,” Ehrlich says. “You can’t go show them to everyone under the sun; it’s illegal.”

Regulation D defines an “accredited investor” under Rule 505. Those investors include a person with a net worth of at least $1 million or a person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years. Under the rule, sales can be made to an “unlimited” number of these “accredited investors” and up to 35 other persons who do not meet the “wealth standards.”

A former hedge fund trader, however, says he feels traders often avoid publicity for other reasons.

“They don’t want to draw attention to themselves,” says the former trader, who asked to remain anonymous. “When that happens, they fall under the microscope (of regulations).”

Hedge funds aren’t regulated by the Securities Exchange Commission or the National Association of Securities Dealers, as most other financial trades are. Hedge fund traders most commonly trade on their own accounts, which exempts them from registering with traditional oversight agencies.

“If yo u’re a broker or a brokerage firm, you must be registered with us,” says Michael Robinson, a spokesman for the National Association of Securities Dealers, a national organization that oversees stock brokers and dealers. “If you transact in the securities business, you have to be a broker.”

Donald Hoerl, assistant regional director of enforcement for the Denver office of the Securities Exchange Commission, says that while he cannot comment on particular hedge fund traders or entities, generally hedge fund practices aren’t unusual or illegal.

“There are certainly circumstances where it’s not illegal to trade on your own account. A lot of different individuals and entities do that,” Hoerl says. “Just because we see all of this doesn’t mean very much at all one way or another.”

Most say the hedge fund label can be given to a variety of money management “strategies,” many of which involve initial public offerings, or IPOs, securities, bonds and financial futures.

Boulder Hedgehogs uses a managed bond portfolio strategy offering government-backed securities with attractive returns, Wolpoff says. He declined to comment on specific rates of return. He emphasized, however, that his company concentrates on government securities and not IPOs.

A few top performing hedge funds have returned more than 50 percent on investments, according to a 1996 Business Week article. And overall, their returns were higher, averaging almost 22 percent annually in a five-year period, than Standard and Poors (16.6 percent).

The funds, after years of stagnation, are hot again, Ehrlich says.

Nevertheless, certain fund strategies, such as that used by international financier George Soros, have taken a hit recently. Soros’s $7 billion Quantum fund suffered recently when managers bet too big on the free-falling Japanese securities market.

People invest in hedge funds, “because they believe in the track record, they believe in the management capabilities,” Ehrlich says. “It’s the same reason you invest in venture capital or mutual funds. It’s very rare you tell the money manager what stocks to buy.

“There’s a lot of saturation, people own bonds, stocks, they’re looking for a new asset class,” Ehrlich says. “Not that they’re counter-cyclical. It’s a portfolio theory (to) diversify into other assets.”

Managers with experience apparently can make lucrative trades. The former Boulder hedge fund trader saw a colleague make an estimated $10,000 in two weeks. Under terms of his work, an investor would deposit a minimum of $500,000, the man says.

“You’re a broker’s broker. The brokers don’t want to deal with you as a broker, so you have a little bit of subterfuge, and act as a client, because you are a client, and you want the money,” the man says. “When you settle the trade, the bank has to make sure the settlement will work. So you leave $500,000 at the bank to show for the settlement.”

The strategy of the company he worked for was to trade bonds, the man says. His former colleagues found buyers and sellers for the same bond and matched those trades through big investment banks. Initial public offerings also make for good trades, he says.

“Hedge means reducing risk, and some of the hedge funds take very little risk,” the man says. “They (former colleagues) are called flippers’ — flipping bonds and IPOs.”

Some local branches of investment firms like Paine Webber have changed their own internal rules to prevent dealing with hedge fund traders “trading on (their) own accounts.”

According to John McFerron at Paine Webber’s Boulder office, hedge fund traders in the late 1980s made money by buying newly issued IPO stock from larger firms, then selling it at a higher price somewhere else before they paid the original bill.