The way the hedge fund industry is structured encourages – even pressures – managers to lie and cheat.
By Les Leopold
Now that you’re more familiar with rigged bets, you may be asking, “Do you really have to cheat in order to make it into the million-an-hour club?” Well, it depends on what you mean by cheat and have to.
Widespread Cheating Or A Couple of Bad Apples?
You absolutely don’t have to, hedge-fund supporters assure us. There are only a few rotten apples in the hedge fund barrel, writes the ever-optimistic Sebastian Mallaby:
An industry of around 9,000 hedge funds is indeed bound to harbor some criminals. But insider trading is already illegal, and prosecutors have the tools to go after offenders in hedge funds without new regulations. The number of fraud cases suggests that regulators are not shy about using these powers, and hedge funds regularly experience inquiries from the SEC when they happen to trade heavily in a stock ahead of a price-moving announcement.
Moreover, some of what politicians and journalists label “hedge-fund abuses” involve leaks of inside information from investment banks rather than from hedge funds, making the hedge-fund managers who receive the leaks accomplices rather than the chief offenders.
You’ve got to admire how far Mallaby will go to exonerate hedge funds — golly, they ’re not really bad crooks. They're not the “chief offenders.” They only drive the getaway cars!
But how many getaway drivers are there? How does Mallaby or anyone else know that hedge-fund cheating is not widespread? And how, for that matter, would we prove the opposing view — that foul play is endemic in the hedge-fund industry? In fact, until a lot of “accomplices” are wiretapped or tell all, it's virtually impossible for outsiders to really know the extent of the cheating.
Case Study: Jim Cramer
We need to hear from an informed insider, someone who has run a major hedge fund, someone who hasn’t been nabbed and isn’t just talking to cop a plea. Yet, what hedge-fund manager in his right mind would dare to tell all about the lawless world of hedge funds?
Enter Jim Cramer, the frenetic star of the highly successful CNBC show Mad Money. Before he became a TV star, Cramer made tens of millions of dollars running his own hedge fund, one of the most successful ever. Yet, unlike others in this famously mysterious field, Cramer talks about it in his entertaining autobiography, Confessions of a Street Addict.
In 2002, Cramer drew a gory picture of the cutthroat tactics required for hedge-fund survival. Five years later, in an interview on TheStreet.com (a website he cofounded and still co-owns), Cramer admitted that the industry actually pushes people, including himself, out to the ethical edge — and beyond.
Wall Street Alpha Male
After college, Cramer nailed a job at Goldman Sachs and then put in four years on its sales force. With his energy and charm, he was a budding star with a knack for landing big accounts. Yet, his real passion was playing the markets himself. He soon found the means to set up a hedge fund with his wife, Karen, a.k.a. “The Trading Goddess.” During the late 1980s and the 1990s, he traded like a wild man— and became exceedingly rich in the process.
Jim Cramer was a man possessed and obsessed, outworking everyone, all of the time. And he absolutely detested losing money. In an industry of alpha males reaping alpha profits, he had to have A-pluses on all of his report cards. He drove himself to make the highest returns, year after year, beating all of the biggest names every time. He was ablaze with energy.
Cramer clearly wanted us to understand that he made his millions by working harder than everyone else in the universe — and millions he made. For a full decade starting in 1987, Cramer and Company (later renamed Cramer-Berkowitz) averaged a 23 percent return per year. That means, if you invested $1 million with Cramer, in 10 years it would be worth $6.4 million.
Making The High Water Mark
In one good year, the value of Cramer’s hedge fund went from $300 million to $400 million. While Cramer took 1 percent of the assets as his administrative fee, he and his wife took 20 percent of the profits, too.
That’s a tidy $20 million in one year — in addition to the $4 million Cramer was paid to run the office. (Today, most hedge-fund managers continue to skim 20 percent of the profits, while administrative costs are usually 2 percent or more of the assets under management.)
Yet there ’s a catch: You get your 20 percent only when your returns take the fund over what’s called the “high-water mark.” If you lose money, then you won’t collect another 20 percent until you make up those losses and bring your fund back past the last high-water mark. So you can never afford to lose money.
Then there are those dreaded redemptions. That’s when the fund’s investors decide to take their money and run. Each year, hedge funds offer investors a window of time — perhaps a few days, two or three times a year — when they can take out some or all of their funds.
Pressure To Perform Leads To Cutting Moral Corners
If your fund is losing money, your investors may run for the hills, making it nearly impossible to get back to your high-water mark. You risk going into a rapid death spiral, as more and more investors flee. Suddenly, you’re toast. It's not uncommon, and it can happen very quickly.
Jim Cramer was desperate to avoid such a dismal outcome. At stake was not only his huge hedge fund, but also his growing media presence, including his regular appearances on shows such as CNBC’s Squawk Box. If his hedge fund failed, his entire media persona would crumble as well. He had more to lose than money.
To avoid such a disaster, 10 years later Jim Cramer finally tells the truth about how the hedge fund business really works. As How To Make A Million Dollars An Hour reveals in detail, he admits to cheating, violating the law, and manipulating his media with misleading news tips (including his colleagues at CNBC).
In the end, he provides the ultimate indictment of hedge funds: “These are all the things you must do. And if you're not, maybe you shouldn’t be in the game.”
Step 6: Rig Your Bets
Step 5: Betting Is For Chumps
Step 4: Use Other People's Money
Step 3: Rip off Entire Countries Because That's Where The Money Is
Step 2: Take, Don't Make
Step 1: How To Make A Million Dollars An Hour In Twelve Easy Steps