Brocade Communications was expected to reassure investors last week that its proposed $2.6 billion acquisition of Foundry Networks was still on track. Instead, Brocade gave Foundry permission to find another buyer.

Brocade revealed the new terms in an updated filing of its merger documents with the Securities and Exchange Commission. Brocade and Foundry also agreed to other conditions that make their deal less firm.

It is the idea that Foundry is allowed to find a new buyer that is unusual. Brocade and Foundry agreed that between Nov. 7 and Nov. 21, Foundry could not only accept other merger proposals, but also solicit them. Such clauses, known as go-shop agreements, have been used in the past — but rarely, if ever, so long into the merger process.

In addition, the merger agreement still allows the companies to call off the merger if it isn’t completed by Dec. 31. That plays into financing concerns. Brocade recently abandoned a $400 million high-yield offering to finance the deal, leaving in place a $1 billion term loan that was arranged months ago to finance the merger. Still, there is no such thing as enough security in these markets, and investors have been nervous that the newly structured deal could allow the lenders to renegotiate the terms of the loan.

It was the latest twist in the long-running saga of the two companies, whose deal continues to make merger arbitragers nervous. Arbitragers are the investors who bet that mergers will close, and they closely watch the “spread,” or difference, between the stock price of a company and the price at which it will be acquired. The renegotiated deal values Foundry at $16.50 a share, but Foundry’s stock price is still trading below that, at around $15.25 a share.

$18.50 in cash, without interest, and 0.0907 of a share of Brocade common stock, par value $0.001 per share, subject to adjustment for stock splits, stock dividends and similar events. Pursuant to the Amendment, each outstanding share of Foundry common stock will be converted into a right to receive $16.50 in cash, without any stock consideration.

Mark Cuban is many things, but “furtive” is not yet one of them. Nor does he play small.

Yet the brash millionaire stands accused of committing one of the most quiet crimes on the books: insider trading, and not even for a profit: simply to avoid losses of $750,000, which would be a minuscule portion of his estimated $2.8 billion fortune. The Securities and Exchange Commission today charged Cuban with selling his entire 6% stake in Mamma.com in June 2004, just before the Internet startup announced a $16.6 million equity offering that Cuban feared would be dilutive. The offering was of a type known as a private investment in public equity, or PIPE.

Whether or not Cuban’s actions are ultimately proved to be insider trading, as the SEC alleges, one thing is clear: the investment in small search engine Mamma.com — “the mother of all search engines” — was a bad deal for the billionaire, who made profitable investments in a passel of Internet companies.

If Cuban first suspected his actions constituted insider trading, he didn’t attempt to keep his motivations private. He told a trade journal reporter freely that he sold out of Mamma.com after he learned of the PIPE offering. “I hate when companies do PIPES-type transactions to raise money,” Cuban said in an email to the reporter. “It’s dilutive, and I hate being diluted…that simple.” The SEC’s official complaint shows that Cuban complained about not being legally able to sell his shares, and then promptly sold his shares. When news broke of Cuban’s move, the company’s stock fell another 15%.

More recently, Cuban advised readers of his blog, Blog Maverick, to watch out when trying to become rich. “There are no shortcuts. NONE,” he warned, noting that many would seek to give false tips on great deals. “I don’t broadcast my great deals. I keep them all to myself.”

Cuban would have done well to take his own advice. When he first announced his investment in Mamma.com, he was publicly enthusiastic about it. But Mamma.com was not what anyone would call a great deal. In fact, it would be better known as a deal from hell — particularly that June 2004 PIPE.

The PIPE deal was just among the earliest problems in Mamma.com’s scandal-plagued history before it changed its name to Copernic in 2007. The company was being investigated by the SEC as far back as April 2004 for a mysterious March runup in its stock, which boosted the shares over 150% — the same runup that convinced Cuban to buy the shares.

And the same PIPE deal that caused Cuban to sell his stock later was at the center of a class-action lawsuit. In 2006, long after Cuban sold his stake, the company paid $3.15 million to settle class-action litigation. Plaintiffs accused the company of taking a significant investment and advice from Irving Kott, the scandal-plagued investor behind First Commerce Securities and J.B. Oxford, who had been accused of stock fraud.

The lawsuit maintained that Kott’s offshore investment funds bought the bulk of Mamma.com’s shares sold in that 2004 PIPE, and that Kott had influence over the company’s operations — even earning the nickname “Godfather,” according to the complaint. Kott’s involvement with Mamma.com was disturbing to both the SEC and PricewaterhouseCoopers, which said it would withdraw its audits of the company’s financial statements unless the truth were disclosed.

Of course, insider trading is considered notoriously hard to prove, which means the SEC has an uphill battle. The SEC alleges that Mamma.com’s executives and bankers provided Cuban with confidential information about the PIPE deal, on the condition he wouldn’t sell his shares until the announcement was public. Cuban sold his shares on June 29, 2004. The company announced the PIPE offering by 6 p.m. that day, making the difference between his sale and the announcement a matter of hours. Still, even those few hours saved Cuban a 9% loss on the value of his shares.

Cuban disputes the charges and posted his statement today on his blog: “This matter, which has been pending before the Commission for nearly two years, has no merit and is a product of gross abuse of prosecutorial discretion. Mr. Cuban intends to contest the allegations and to demonstrate that the Commission’s claims are infected by the misconduct of the staff of its Enforcement Division. Mr. Cuban stated, ‘I am disappointed that the Commission chose to bring this case based upon its Enforcement staff’s win-at-any-cost ambitions. The staff’s process was result-oriented, facts be damned. The government’s claims are false and they will be proven to be so.’”

Goldman Sachs has always been considered the leader in investment banking, so it’s no surprise that the firm felt the need to apologize on behalf of the entire industry for creating the current crisis.

“While the firm has distinguished itself through many aspects of the crisis, we cannot ignore the fact that we are part of an industry that is directly associated with the ongoing economic distress,” a spokesman for the firm told our colleague, Sue Craig, as he confirmed that Goldman’s top executives will get only their base salaries of $600,000, with no bonuses this year.

A cynic might reply to that, “What industry?” Investment banking, as we know it, is dead. The markets have steadfastly refused to accept Goldman Sachs’s assurances that nothing at the firm will change. Goldman’s shares are trading at about half the value they had even a month ago. Investors are concerned that Goldman Sachs has no industry any more, that the one-time leader of Wall Street is now a king without a country.

Blankfein and his team may be the only ones at the firm to entirely forgo bonuses, but others at the firm will see deeper cuts than they have in over a decade. Debt markets dried up this year, with investment grade debt monthly issuance volume declining 57% versus last year and high yield issuance down 97%, according to research from buyside firm Sanford C. Bernstein. Equity markets also suffered, with 97% less money raised in initial public offerings this year compared to last year. Several capital-raisings by financial firms, including J.P. Morgan, Goldman itself, and Wells Fargo, are not enough to offset the larger slowdown in equities. Bernstein expects equities revenues to fall 45% at Goldman for this year. Goldman’s investment-banking revenues could see a 55% decline compared to the fourth quarter of 2007, Bernstein suggested.

Goldman’s principal investments business — in which the firm invests its own money — is also likely to suffer as Bernstein predicts a writedown on Goldman’s stake in Industrial & Commercial Bank of China.

The best prospects for decent bonuses are the investment-banking old school: the M&A bankers who fell out of favor for years as fixed-income brought in the lion’s share of profits. The mergers advisory business has done well, which translates to only a 37% decline since the fourth quarter of 2007. In particular, Goldman’s financial institutions group, or FIG, should do well since nearly one-third of the completed M&A transactions in the quarter occurred within the financial space, and 60% of the capital-raisings, according to Bernstein research.

Goldman is the first to acknowledge that bonuses might be a powerful show of contrition this year, but if its history of leadership is any indication, it won’t be the last. UBS announced that it will put all of its bonuses in escrow. Citigroup is laying off 50,000 employees and selling off assets, while preparing to cut bonuses of highly paid employees. Cutting bonuses and staff will comfort shareholders that Goldman and its rivals won’t profit while shareholders suffer. But, while symbolically welcome, it won’t solve the one thing shareholders want most: a return to profitability.

BHP Billiton: So it’s not quite the mega-deal it was when it was announced just over a year ago, but who are we to sneeze at what could be a $68 billion deal. The Big Australian expressed confidence this week that it could come to a “manageable agreement” with EU regulators and is looking at a variety of concessions.

Wells Fargo: As Deal Journal has pointed out numerous times, getting financing in this market is a remarkable feat. Wells Fargo became the latest company to pull it off, raising $12.65 billion this week. Now it wasn’t quite J.P. Morgan Chase raising $11.5 billion for its coffers in just 24 hours, but it’s still impressive.

Lazard: How much has Wall Street changed since September? Just try to answer this question: Who is the largest securities firm regulated by the SEC? If you guessed Lazard, you are correct. And for its position as the new king of Wall Street, it makes the winners list this week.

General Motors: The future of Detroit hangs in the balance and all eyes are on the GM. The giant auto maker’s stock fell to its lowest level since 1946 as concern intensified that the auto maker could run out of cash and be forced to file for bankruptcy protection. Meanwhile, the bailout it has lobbied Washington for has stalled.

Citigroup: Citi’s shares are trading below $10; it is handing out pink slips to at least 10,000 employees in its investment bank and other divisions; and the board of the giant bank is considering replacing its chairman. And that’s just this week’s news. It seems Citigroup has moved back to the top of the list of troubled banks.

TARP: If at first you don’t succeed try, try again — and again. The Treasury announced this week that would no longer use TARP money to purchase troubled assets from banks. Instead it will use the money to stake in financial firms. How did this change go over on Capitol Hill? Uh, not so well. The real question now is how much more will be needed.

American International Group: In a week that saw the troubles of Citigroup and GM take a turn for the worse, it is easy to forget the black hole that AIG has become. The U.S. government reached a deal to scrap its original $123 billion bailout of the insurer and replace it with a new $150 billion package.

“Hedge funds don’t employ a lot of voters; they have small staffs.”

This wry statement came from Pershing Square founder William Ackman. Ackman has become something of a de facto spokesman for a certain swath of the hedge fund industry: whether it comes to short-selling or activism, he is willing to be outspoken for an industry that usually keeps its thoughts to itself — except when it is forced to testify before Congress.

David M. Russell for The Wall Street Journal

That’s why we took notes earlier this week when Ackman joined Greenlight Capital founder David Einhorn and Third Point Capital founder Daniel Loeb to discuss the financial crisis at an event sponsored by New York’s Center for Jewish History. During the wide-ranging discussion, Ackman and his fellow activists discussed what they wanted from an Obama administration. Loeb and Einhorn largely agreed with what Ackman proposed as a wish list for the Obama administration.

So what should President-elect Obama do first to handle the financial crisis? Here is what we heard.

1. A “really good” Treasury secretary who is a man of action, like Hank Paulson, but receptive to ideas.

As you would expect, the “ideas” in question may well come from the hedge fund industry. Hedgehogs have traditionally kept Washington lawmakers at arm’s length — or the end of a 10-foot pole. As this week’s Congressional hearings showed, however, hedge funds are now willing to step into the fray with solutions for the financial crisis. That is especially true when it comes to valuing debt securities and the regulation of derivatives, including credit-default swaps. Hedge funds often don’t like investment banks — their frequent trading partners — but neither do they want the alternative of too much government interference in money matters. “I don’t think the government should be setting the price on financial assets,” Ackman pointed out with respect to the Treasury’s abandoned plan to buy troubled mortgage assets.

2. A chairman for the Securities and Exchange Commission who is sympathetic to short-sellers.

There is self-interest in Ackman’s support of a short-seller-supportive regulator, of course. But dig deeper: Hedge funds as a whole were taken aback by the spur-of-the-moment ban on short-selling. Ackman wants an SEC chairman who acknowledges the short-selling ban was a mistake and will never again make sweeping changes without extensive public discussion.

3. Fix the Fannie/Freddie restructuring.

Fannie Mae and Freddie Mac are under government control, but the situation at the government-sponsored enterprises is no better. In Ackman’s opinion, the Fannie Mae and Freddie Mae bailouts were too influenced by political concerns rather than economic ones: “We want key players to act in an economically rational, apolitical fashion,” he said. Ackman did not provide specifics on what the government should do with Fannie and Freddie — but then, that’s what lobbying trips are for.

So says Congress: Treasury has done a terrible job of managing the bailout. That’s why Treasury should get expanded authority — for instance, to approve bank mergers.

Such paradoxical statements make perfect sense to some Congressional leaders, including New York Democratic Senator Chuck Schumer. Yesterday, Schumer called on Treasury to become the chief regulator on bank mergers, with the power to approve or deny them. Schumer’s approval matrix is simple: he wants Treasury to strike down any proposed mergers that would be financed with money from the $700 billion Troubled-Asset Relief Program, or TARP.

Associated Press

Of course, the job of approving bank mergers is already assigned, to several agencies: the Federal Reserve, which gets final approval; the Office of the Comptroller of the Currency, which charters banks and makes sure they are solvent; and the Office of Thrift Supervision, which serves a similar purpose.

And presumably there is value in bank mergers – even TARP-financed ones – that help cushion lending losses and stabilize the broader lending system.

So why would Schumer want Treasury to officially take over a job that is already handled ably, by agencies and regulators that Treasury ultimately controls or influences? We can think of at least two reasons Schumer would prefer Treasury to get involved: to give Congress a bigger say in bank mergers and to circumvent infighting by bank regulators. In both cases, Schumer is turning Paulson’s imperial turn as Treasury Secretary — where he expanded the powers of the agency to new limits — to Congressional advantage.

Perhaps what Schumer realizes is that Paulson has created his own political paradox: The more powerful Treasury gets, the more powerful Congress gets. Each of Paulson’s new powers had to be granted to him by Congress. Senators and Representatives gave him the ability to pour Treasury money into Fannie and Freddie and the power over TARP, as well as the power to effectively nationalize the nation’s banks. But Congress has far less power over the OTS or OCC; to get to them, Congress would have to go through Treasury anyway. How tempting, then, to eliminate a step, and just have Treasury leapfrog over the lesser agencies.

And just how might, say, Treasury – and by extension Congress – arrive at the “no gobble” standards that Schumer addressed in his prepared statement?

There are mergers that should take place to improve systemic stability and encourage lending–for a very weak institution, a merger may be the right way to go. But what should not be endorsed is giving away government money so that it can be used to gobble up competitors that will not have any impact on the overall stability of the financial sector.

In an interesting bit of jujitsu, Schumer could also turn Paulson’s weight against him to break the logjam in bank regulation. The three bank regulators — the Fed, OTS and OCC — often compete with each other, and rarely voluntarily share information. Congress wants transparency.

Other politicians are, of course, getting into the act. U.S. Senator Sherrod Brown, a member of the Senate Banking Committee, objected to AIG’s plan to pay over $500 million to executives and other employees as part of a firm-wide retention plan: “American taxpayers must not foot the bill for fattened AIG paychecks. It is outrageous that AIG would even consider inflating executive salaries. AIG has received more than $152 billion in taxpayer funds while 10 million Americans stand on unemployment lines. This decision is a slap in the face to the millions of middle class families whose tax dollars AIG is borrowing. Company executives should be ashamed of themselves. This action should be immediately rebuffed by the Treasury Department and reversed by AIG.”

Schumer and other politicianss should not expect to win their points easily. They may have decades of experience on his side, but Paulson has nimbleness. And, while Paulson has only two months left in office, he has also shown that he can make massive changes to his benefit in a lot less time.

Related Reading

The U.S. Treasury: The World’s Biggest Hedge Fund
Hank Paulson: How to Run a Regulatory Coup

The laws of capitalism — even today’s highly impure version of it — are unyielding.

The strongest companies survive. The weak and infirm die. And the economy moves forward.

When times are tough, like today, capitalism’s “creative destruction” accelerates. Rather than decades, industry restructurings take just years.

For workers, this unfortunately means job losses by the millions. But think of restructuring as a heavy dose of economic chemotherapy. Awful and painful. But there’s no real choice for getting healthy again.

Look around. America’s banks, insurers and retailers are dropping like flies. The lucky ones are bought. The unlucky file for bankruptcy. By the end of next year, the results of all this will be clear enough: duopolies and oligopolies will rule the U.S. economy.

This week, DHL, the overnight delivery division of Deutsche Post, threw in the towel. It announced it would shutter its domestic U.S. operations and lay off 9,500 people.

DHL’s failed attempt to compete with UPS and FedEx, who together control 80% of the U.S. market, will end up costing Deutsche Post almost $10 billion by the end of next year.

But when the choice is throw good money after bad or concede defeat, Deutsche Post did the right thing. Deutsche Post’s shares rose 7% on the news.

The U.S. Postal Service, another competitor to UPS and FedEx, just announced a $2.8 billion loss for its 2008 fiscal year. If the post office wasn’t funded directly by the U.S. taxpayer, it too would be gone soon enough.

Which is what happens when capital is scarce. Unprofitable companies disappear. The strong survive and thrive.

Look at the ascendancy of AT&T and Verizon Wireless. The nation’s number one and two wireless operators are busy buying up their competition.

Meanwhile, Sprint Nextel, the nation’s number three wireless operator, struggles to survive. Last quarter, it lost 1.3 million subscribers.

To stem the tide, Sprint needs a deep and stable capital base. But Sprint has a junk rating of BB and carries almost $23 billion in debt. As for the prospect of raising equity, good luck. In the past year, Sprint’s shares have fallen from over $16 a share to about $2.

By further cutting prices, Verizon and AT&T could probably push Sprint to the brink. After all, AT&T and Verizon still have access to capital. Last week, AT&T sold $1.5 billion in five year notes.

But duopolies like the regulatory cover of a third player. So it’s probably in Verizon and AT&T’s interest for Sprint to stay afloat.

The sorting of the winners and losers is the brutal process by which “capital” is allocated in “capitalism.” Eventually, a healthier economy will emerge, as risk capital flows once again to new and smaller companies to challenge the stronger firms.

That’s why the formation of the U.S. banking oligopoly now underway will be a good thing — at least for some period of time. The U.S. financial system will come to be dominated by J.P. Morgan, Bank of America and Wells Fargo plus maybe one or two other banks.

And yes, soon enough, the banks will be charging $35 for an overdraft versus today’s average of about $30. Or maybe $4.50 to use another bank’s ATM versus the current average of just under $3.50.

But is that too steep a price for a simple, stable banking system that Washington can properly regulate? And that will actually allow the nation’s capital to flow?

Economic chemotherapy works. Lawmakers in Washington might want to consider this as they turn their attention to bailing out Detroit.

Capitalism wants only three or four global car companies. And what capitalism wants, it eventually gets.

Citigroup is in a challenging situation right now. The firm plans to cut 10,000 jobs . The Journal reported yesterday that Citigroup is considering replace chairman Win Bischoff with lead director Richard Parsons.

This morning, Parsons sent this cheery note to Citigroup employees to reassure them about the future of “Sir Win” — as he calls him — and urges Citigroup employees to hang in there.

Deal Journal reprints the full memo, below. For context, we’ll point out that the Journal stands by its reporting — a fact that is included in today’s story — and that news reports from other publications, linked below, also report that Citigroup’s board has considered replacing Bischoff.

To: Citi Employees
From: Citi Board of Directors

It is important for us to communicate with you directly in light of recent media coverage of our company. The news coverage about the Chairman of our Board, Sir Win, is irresponsible and completely inaccurate, and we want you to understand and appreciate our perspective on it.

The Board of Directors and management are operating as one team completely aligned on critical issues, opportunities, and the direction of the company. This is especially important given the extraordinary times in the market and the challenging economic environment we face.

We don’t need to review with you all the things that have been accomplished is such a short period of time, but to highlight just a few:

* Nearly $50 billion in new capital raised prior to the additional $25 billion from the US Treasury.
* A reduction in legacy assets by more than $100 billion since the first quarter in addition to divestiture of a number of businesses.
* The decline of expenses for three consecutive quarters.
* The establishment of a new risk organization, with highly talented professionals, and the reduction of risk overall.
* The reorganization of our businesses to serve our customers better and to help make our people — our most important asset — as productive as possible.

We are confident that the direction our management team has set is the right direction — and the winning direction — for these extraordinary times. Citi is well positioned for growth because of its unique global universal bank model, and because it has the right talent, the right management, and the right approach.

Considering the significant adversity presented by a sustained global market downturn, all of your accomplishments have been nothing short of extraordinary. You are leading by example and you have our full support and appreciation.

Keep the faith!

Richard D. Parsons
Lead Director

Related Reading

Citi to Cut More Jobs, Raise Rates on Plastic [WSJ]
Citi Directors Mull Replacing Chairman [WSJ]
Boardroom tensions highlight Citi divisions[FT]
Worst May Be Yet to Come for Citigroup [NYT]

Dow Jones Newswires colleague Victoria Howley sends this dispatch from London about Barclays.

Barclays executives will meet Friday with some main investors. If the executives can’t quell opposition to a ₤7 billion capital-raising plan that will sell almost a third of the bank to Middle Eastern investors, then management heads could roll, bankers said. Barclays has agreed to sell as much as a 32% stake in itself to Qatari investors and Sheikh Mansour Bin Zayed Al Nahyan, a member of Abu Dhabi’s royal family. Qatar and Sheikh Mansour would each invest ₤1.5 billion in so-called Reserve Capital Instruments, which will pay a generous 14% dividend for ten years.

The bank aims to raise further capital by issuing ₤2.8 billion of mandatory convertible notes to Qatar Holding, Sheikh Mansour and Challenger Universal Ltd., the family investment vehicle of the Qatari Prime Minister.

Chairman Marcus Agius will host the meeting as part of the bank’s efforts to soothe shareholder dissent as investors prepare to vote on the deal Nov. 24. Barclays would need to persuade the Middle Eastern investors to accept any modification to the deal because it has signed a binding agreement with them.

It’s unclear whether the investors would agree to such a request. Qatar Holding is already facing losses from a previous Barclays investment. Dissenting shareholders say that Barclays should restructure the deal. The deal would be more palatable to them if they could subscribe to the RCIs, or if the securities were cheaper because they have a shorter duration, another banker said.

“Its a lousy deal. Right now we haven’t decided how we will vote, but we think there is a real risk that Barclays may lose this vote,” a leading Barclays shareholder said.

Shareholders are unhappy because they cannot participate in the full capital raising, which will dilute their existing stakes in Barclays.

The cost of the deal is an issue as well.

“Our main concerns are that it’s an expensive package, with potential for a large dilution and that shareholders’ pre-emption rights have been ignored,” said Roger Lawson of the U.K. Shareholders Association, which represents private shareholders in the U.K.

Legal & General Investment Management, which holds a 5% stake as Barclay’s largest shareholder, and Aviva Investors, with a 1% stake, have already indicated they will vote against the plan, one banker said.

LGIM and Aviva declined to comment.

If it loses the vote, Barclays will have to backtrack on its decision not to accept U.K. government funding, and the future of Chief Executive John Varley and other executives could be in doubt, the banker added.

A defeat for Barclays could also have implications for the firm’s already plummeting share price. The stock closed Thursday at 157.7 pence, down 52% from 331 pence on June 25, when Barclays announced a circa GBP4.5 billion share issue to shore up its balance sheet.

Barclays sought out private investment to avoid having the U.K. government as a shareholder and to protect its commercial freedom. President Bob Diamond favors international expansion, which the government has banned if banks use Treasury funds.

But the amount of control the government wants to exert in return for its cash now seems less onerous.

“We can understand the initial reluctance and fear with regards to possible government interference, but from what we’ve seen so far, the government appears to not want to interfere too much,” the Barclays shareholder said.

Barclays declined to comment.

Reuters

Hedge fund directors George Soros (L-R), chairman of Soros Fund Management LLC, James Simons, director of Renaissance Technologies LLC, John Alfred Paulson, president of Paulson & Co Inc, Philip Falcone, senior managing director of Harbinger Capital Partners, and Kenneth Griffin, CEO and managing director of the Citadel Investment Group, are sworn in to testify before a US House Oversight and Government Reform Committee hearing on the regulation of hedge funds, on Capitol Hill in Washington November 13, 2008.

A hedge fund manager recently quipped in our presence, “regulating hedge funds is like protecting millionaires from billionaires.”

And yet, this cadre of financial elites can be quite populist when they want to — particularly when they can share the U.S. taxpayers’ frustrations against the appointed scapegoats of the crisis: investment banks and ratings firms. Both the banks and the ratings agencies have been rivals and obstructions to the greater glory of hedge funds, and we have sensed the hedge funds’ need for revenge.

So, as five prominent hedge fund managers testify today in front of the House Oversight and Government Reform Committee — you can see our introduction to the proceedings and some of the statements here — Deal Journal tuned in, expecting to hear a lot of hedge funds prove how they share many of the same interests as average taxpayers. We weren’t disappointed, as Congress quickly identified the hedge-fund managers as governmental allies against the investment banks. We’re live-blogging it.

Update: You can read the full transcript here. The hedge fund managers’ testimony starts on page 117.

12:25: Phil Falcone of Harbinger Capital Partners gives his opening remarks. He looks like a besuited John Lennon, with round glasses and artfully shaggy hair. He wants Congress to know this: Compensation in the hedge fund world is performance based, and that works. Short-selling is a long-standing and valuable feature of our markets.

12:27: We were so right about the populism. Falcone points out he grew up working class, and his mother worked in the local shirt factory. It includes details of the square footage of the house he grew up in. “Not everyone who runs a hedge fund was born on Fifth Avenue. That is the beauty of America and the beauty of our industry.” Very Horatio Alger, and it shows the savvy Falcone knows his audience. Congress eats this up as a great support to Main Street. Our president was just elected on a similar platform, after all.

12:28: Harbinger is doing well, and that’s fine. But it’s bad for management of companies to take compensation when the company is failing, Falcone says.

12:29: Hedge funds encourage “outside the box” thinking. Isn’t that part of the problem? Or rather, that no one can see the box, or know what’s in it?

12:30: Falcone says, “While I was growing up, my family may have lacked money, but we didn’t lack integrity in what we did and how we did it….I love this country and am grateful for the opportunity I’ve been provided.” He wants people to see the hedge fund industry as “part of the solution for the economic turmoil.” Cue the Star-Spangled Banner.

12:32: Ken Griffin of Citadel is up next. “We call financial risk-taking research and development.” Good line.

12:34: “The concept of ‘too interconnected to fail’ has replaced ‘too big to fail,” Griffin says. Another good line. The Committee appears to be silently sizing up his speechwriting ability.

12:36: Questions begin. “Witnesses will not be required to answer questions unrelated to the topic of today’s hearing,” Waxman warns. Later, this turns out to be unfounded, as the Committee is all too eager to talk about the topic of today’s hearing. At length.

12:37: Waxman begins at the beginning: with systemic risk. He brings up Long-Term Capital Management, which was leveraged about 30 times and nearly collapsed, requiring a government-brokered bailout. Seriously, everyone in the entire hedge fund industry could devote the rest of their lives to digging wells for poor villagers in Africa, and they will still never be absolved from the LTCM debacle.

12:38: George Soros starts, in his euphonious accent. The power of hedge funds does justify greater financial regulation, he says. Just like that! We’re surprised, since the industry fought regulation for years. But then, he didn’t make his money by being on the wrong side of a trade, even a political one. Most of the others agree.

12:41: John Paulson says that hedge funds do not need as much control over their use of leverage as banks and financial institutions. “The problems at LTCM were minuscule compared to the $150 billion at AIG, the $700 billion in the TARP program, or even the capital advanced to GE.”

12:43: Falcone: “With $1 trillion outstanding…the industry is not nearly as levered as some of the banking institutions we did business with over the past few years.”

12:44: Griffin points out that LTCM was saved by private institutions — 13 banks — and advertises Citadel’s work with J.P. Morgan in finding a solution to the collapse of Amaranth. (Citadel also has a joint effort to create a derivatives clearinghouse CME.) This is sort of like product placement in movies, but with complicated financial systems. He advocates private-market solutions like that. Griffin is the first to say he believes that the hedge fund industry does not need more regulation. Waxman breaks in to note that some of the private-market solutions were brokered by the Fed. Griffin shoots back, “If we look at the stress points, they have been in the regulated institutions like AIG.” Oh, snap. Hedge funds have not been part of the carnage, he notes. Well, that’s not exactly true — plenty have gone out of business — but it is true that the failures of regulated institutions were much, much larger.

12:45: All of the hedge fund managers say they are willing to disclose their positions, but not to the public — only if the government keeps them confidential. Because the U.S. government is soooo great at keeping secrets, we presume. Griffin dramatically states that asking hedge funds to disclose their positions would be like asking Coca-Cola to disclose the recipe for Coke. Oh, boy. He invoked Coke. Next we expect to hear about the sanctity of the recipes for motherhood and apple pie.

12:52: Paulson: “It doesn’t make sense to me that the government puts in capital, the banks take the capital, and then that capital comes out the other door in the form of dividends.” He wants restrictions on cash compensation, and any bonuses should be paid in common stock (meaning, not in stock options or restricted stock.) This will protect taxpayers and restore badly needed capital to these institutions.

12:53: Simons reminisces about how he suggested to former Treasury official Bob Steel that the government set up a two-sided auction process, matching buyers of troubled assets with sellers of those assets. Great idea, sure, but the problem all along was that there were no buyers. Simons explains that the assets would be significantly marked down.

12:55: Soros says that if the asset purchases were done properly, $700 billion would have been enough to fix the “gaping hole” in the markets. He believed TARP should only have underwritten the securities, not acquired them, and underwritten them on terms that would be beneficial for taxpayers.

12:58: The next questioner points out why these hearings are so mild: every single manager up there has made a ton of money this year. These calm, gathered billionaires are hardly poster children for failure, thus their mild, helpful, even jolly demeanors. The Congressman only cares about one thing, though: How did they do so well?

12:59: Griffin answers first, and much to his credit he confesses that Citadel had a tough eight weeks. He also says that no risk management system would have identified what happened over the past eight weeks. True, true.

1:00: Falcone attributes his firm’s ability to “weather the storm” to their “diligence.” It took him eight to 12 months of analysis before he invested in the mortgage market. Subtext: Hedge funds are thoughtful, and not trigger happy like the banks. Bad, bad banks.

1:08: Soros: “Markets that allow short-selling tend to be more stable than those prohibiting them.”

1:13: Griffin blames the lack of a central clearinghouse for derivatives for pushing “thousands of high-paying jobs abroad.”

1:15: After an incredibly long-winded question that wanders everywhere from George Soros’s recent book to the state of the financial system, Rep. Carolyn Maloney retreads all the answers that the managers have already given: Yes, they would agree to disclosure and transparency.

1:17: Maloney is officially incapable of asking a question in less than 200 words. She yields with respect. Congress is being so much nicer to hedge fund managers than they were to bankers, who received the grilling of their lives in a TARP hearing earlier today.

1:23: Rep. Shays asks questions about whether hedge fund managers should have their money in all of their funds. Griffin notes that the fund he has his money in has lost more money than his firm’s other funds. Soros answers that to avoid precisely that conflict of interest, he has only one fund, and that all his money is in it. Shays asks how that fund’s performance compares to Soros’s other funds. His other funds of…one fund, he means? Shays then turns to Simons, who he accuses of mumbling and cuts off. The remaining two managers race through their answers. Watching Shays work is like watching a drive-by.

1:25 Rep. Cummings says the five managers are “richer than God,” and promises not to disclose their individual compensation, but each of them made $1 billion last year on average, he says. He notes that they are not taxed like normal citizens because they are taxed at lower capital-gains rates. As the managers start to reply, Cummings orders, “I want you to keep your voices up for my questions.”

1:28: Paulson replies, somewhat condescendingly, “I appreciate your concern for the tax code,” or something to that effect. Falcone says that hedge funds should not be treated differently than other investors, and notes that 98% of his income last year should have been taxed as ordinary income. Paulson argues that there’s no problem with taxing short-term capital gains at the short-term rate, and long-term gains at the long-term rates. Griffin compares the tax treatment to being a chef and co-founder at a restaurant; he works every day (slaving over hot convertibles and plating steaming credit-default swaps) and when the restaurant is sold, he pays long-term capital gains. It’s not a complicated concept.

1:33: Rep. Tierney shows himself confused at the difference between management fees –taxed as ordinary income — and carried interest. He also is confusing the basic difference between “goods” and “services,” as he claims that hedge fund managers are not expending effort that requires remuneration when they are investing other people’s money. He basically believes management fees shouldn’t exist. So hedge fund managers should work for free? Great business model. If it applied everywhere, then Congressmen would not get salaries for representing their constituents, right? Then he accuses Griffin of using the restaurant analogy to confuse people.

1:34: Rep. Tierney decides that John Paulson should be in charge of TARP, instead of Hank Paulson. The veering from attacking Griffin to loving Paulson makes us dizzy.

1:38: Rep. Yarmuth launches into a long reminiscences of the hearings that included Angelo Mozilo earlier this year. Keep in mind, the representatives only have five minutes total, including questions and answers. We notice they’re spending much of that time talking, and then cutting off the hedge fund managers later.

1:41: Griffin says corporate leaders need to take risk in order to push innovation.

1:43: Rep. Cooper — apparently moonlighting as a newspaper editor — says grandly that the “headline of this hearing is Paulson v. Paulson: John Paulson accuses Hank Paulson of botching the bailout.” We didn’t hear that.

1:44: Paulson immediately points out that he, um, never criticized Hank Paulson or accused him of botching the bailout. Instead, he believes Hank Paulson has reoriented the bailout in the right way. Sure, but does he expect Congress to let facts get in the way of a good sound bite?

1:46: Rep. Cooper asks how much volatility in the markets is enough. “2,000?” We’d be surprised if he gets an answer. He doesn’t.

1:48: Soros points out that the obsession with risk has left out the importance of volatility and uncertainty. It’s a good point.

1:49: Rep. Cooper accuses Citadel of having a conflict of interest in launching a clearinghouse with the CME. Griffin says there is no conflict because Citadel will contribute intellectual capital, while CME will actually run the clearinghouse. Cooper is not happy with having to rely on a Chinese wall, rather than a real separation.

1:50: Rep. Van Hollen asks, in a two-and-a-half-minute long question, something about hedge fund regulation that takes multiple byways. The question appears to be about regulation, and whether regulators should have greater powers, including setting leverage ratios.

1:52: Soros notes that useful old laws on leverage ratios and other things have fallen out of use and should be reinstated. All the other hedge fund managers agree. Griffin turns the question back to clearinghouses and points out the difference between the “TCC” solution, open only the buyside, and the “Citadel solution,” which would open the clearinghouse for everybody, and it’s in the “interest of our nation and the entire world’s financial system.” Griffin is lobbying like a champ. Call it market efficiency: Why spend time testifying in front of Congress if you don’t also pitch your product?

1:55: Rep. Van Hollen makes an excellent point: the hedge fund industry fought regulation tooth and nail a few years ago. It gives the lie to the current professed willingness to disclose positions and accept stricter regulators.

1:58: Soros points out to Rep. Issa that regulators should understand the instruments they’re regulating, and should not allow the use of instruments they don’t understand. Sensible.

1:58: Rep. Issa throws a softball to Paulson, who he congratulates for earning a 1% return, and asks how Paulson manages leverage. This goes nowhere. We’ll spare you.

2:02: Issa asks why hedge funds should be treated differently than mutual funds when it comes to capital gains. Paulson says perhaps hedge funds should have time horizons of more than one year, and then they would be closer in profile.

2:02: Waxman closes the session with big smooches to the hedge fund managers, the combined billionaire superwattage of which has left the Committee presumably blinded by the fund raising possibilities. Here is what Waxman says: “Congress usually has trade associations here, and they speak in their self-interest. That’s why we wanted to have you here, to get an unfiltered response.” Oh, boy. If Waxman believed the managers were not speaking in their own self-interest, it just highlights how much more Washington needs to understand how Wall Street communicates. Besides, these managers succeeded in the credit crisis, so they have nothing to be defensive about.

2:05: The session ends.