Manipulating a Hedge Fund Blow-Up: A Year Ago the Implosion of Hedge Fund Amaranth Was Seen as a Good News/bad News Story. the Bad News Was It Loss More Than $6 Billion; the Good News Was That Only the Poor Suckers Who Were Invested in It Lost Money. A Recent Congressional Report and Regulatory Action Suggests There Is More to the Story

By Collins, Daniel P. | Modern Trader, September 2007 | Go to article overview

Manipulating a Hedge Fund Blow-Up: A Year Ago the Implosion of Hedge Fund Amaranth Was Seen as a Good News/bad News Story. the Bad News Was It Loss More Than $6 Billion; the Good News Was That Only the Poor Suckers Who Were Invested in It Lost Money. A Recent Congressional Report and Regulatory Action Suggests There Is More to the Story


Collins, Daniel P., Modern Trader


While the huge implosion of hedge fund Amaranth Advisors was a dramatic event--particularly for shareholders--and an embarrassment to the large institutions counted among its investors, it did not shock the industry as the implosion of Long-Term Capital Management (LTCM) did and it did not, at least initially, create similar calls for regulatory action.

In a strange way there was a positive element to the story because despite massive losses, which were more than $6 billion, there was little spillover into other funds and it did not tar the entire industry as LTCM did.

But now a recent congressional study claims there were more victims and is threatening greater regulation of markets and funds as a result. The nine-month study by the Senate Permanent Subcommittee on Investigations (PSI) claims Amaranth increased the cost of natural gas for end users (ie. voters) and added volatility to the markets (see "Findings," right). "In 2006, excessive speculation by Amaranth Advisors altered natural gas prices, caused wild price swings, and socked consumers with high prices," said Subcommittee Chairman Carl Levin (D-Mich.) in the report. "It's one thing when speculators gamble with their own money; it's another when they turn U.S. energy markets into a lottery where everybody is forced to gamble with them."

The report claims Amaranth manipulated natural gas prices and attributes their ability to do so on a regulatory regime that suffers from loopholes due to numerous exemptions and a lack of resources (see "Recommendations," right).

Regulatory experts did not initially agree with the findings of the congressional report but soon followed up with charges of their own against Amaranth and lead trader Brian Hunter.

In testimony before the subcommittee the Commodity Futures Trading Commission's (CFTC) chief economist's overview stated, "The analysis failed to conclude that Amaranth's trading was responsible for the spread price level observed during 2006." The analysis goes on to say, "All of the data are consistent with the hypothesis that the March/April spread, and similar winter/summer spreads, declined due to changes in perception of market fundamentals."

The analysis corresponds with other studies on the Amaranth collapse--particularly the Edhec report conducted by Hilary Till--that Amaranth was making a large bet on a weather event, particularly another severe hurricane season, and as it became apparent that the 2006 hurricane season would not be a repeat of 2005, the large differentials in winter/summer spreads began to shrink causing large losses. Till's analysis also made clear Amaranth held large concentrated positions in natural gas spreads that would make it extremely difficult to unwind without a severe penalty.

WHO'S YOUR REGULATOR?

Amaranth lead trader Brian Hunter filed a complaint against the Federal Energy Regulatory Commission (FERC) in July after he became aware they were preparing to bring charges of manipulation against him. His suit stated that the CFTC is the regulator that oversees Amaranth and his trading and only they had the authority to investigate them. The next day the CFTC filed a civil enforcement action in U.S. District Court against Amaranth Advisors, its subsidiaries and Brian Hunter, alleging defendants engaged in a scheme of price manipulation that violated the Commodity Exchange Act. The complaint alleges the defendants attempted to manipulate the price of natural gas futures contracts on the New York Mercantile Exchange (Nymex) on Feb. 24 and April 26, 2006.

The following day FERC announced a "Show cause order" (SCO) after making a preliminary finding that Amaranth and traders Hunter and Matthew Donohoe manipulated natural gas markets. FERC stated, "Amaranth manipulated natural gas markets through trading on Nymex Natural Gas Futures contracts, whose settlement price determines the price for a substantial volume of Commission-jurisdictional natural gas transactions," and proposed to order disgorgement of unjust profits and civil penalties totaling nearly $300 million. …

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Manipulating a Hedge Fund Blow-Up: A Year Ago the Implosion of Hedge Fund Amaranth Was Seen as a Good News/bad News Story. the Bad News Was It Loss More Than $6 Billion; the Good News Was That Only the Poor Suckers Who Were Invested in It Lost Money. A Recent Congressional Report and Regulatory Action Suggests There Is More to the Story
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