London (CNN Business)The dramatic implosion of Archegos Capital Management is another warning to Wall Street about the dangers of hefty leverage and speculative behavior fueled by rock-bottom interest rates. It's also a wake-up call to regulators about hidden risks within the financial system. "It is a dereliction of duty for regulators at the Securities and Exchange Commission, the Federal Reserve, the Treasury Department and elsewhere, including most prominently the members of the Financial Stability Oversight Council, to allow these systemic risks to continue to build up unseen and unregulated," Dennis Kelleher, CEO of financial reform group Better Markets, said in a statement Monday.
A little-known hedge fund caused widespread chaos on Wall Street
What's happening: Few people had heard of Archegos before this week. But the investment firm is in the spotlight after its bets on media companies using tons of borrowed money and complex derivatives backfired. That forced lenders on Wall Street to step in and demand that Archegos unwind its positions. Major banks, including Credit Suisse (CS) and Nomura (NMR), now face huge losses from their exposure.
Some market watchers expect fallout from the episode will be relatively contained.
"This is likely not Long-Term Capital," Art Hogan, chief market strategist at National Securities Corporation, told my CNN Business colleague Matt Egan. The failure of that massive hedge fund in 1998 threatened the financial system, forcing the US government to intervene. Others aren't so sure, reflecting on the collapse of Bear Stearns hedge funds in the summer of 2007.
"We don't know how far the tentacles go," said Joe Saluzzi, co-head of trading at Themis Trading. "Early in the Bear Stearns crisis, the market was fine — until it wasn't."
Driving these concerns is the fact that there's no paper trail for Archegos' holdings with the Securities and Exchange Commission. Bill Hwang, the firm's founder, ran it as a family office, a type of financial entity that receives little scrutiny from regulators. Family offices — which were pioneered by finance titan John Pierpont Morgan — are used by the wealthy to manage fortunes and pass money from generation to generation.
Ernst & Young estimates that that private family capital is now bigger than private equity and venture capital put together, and that there are at least 10,000 single family offices around the world.
Historically, family offices were not compelled to register with the SEC under the Investment Advisers Act of 1940 because of an exemption granted to firms with fewer than 15 clients.
The Dodd-Frank reforms passed after the 2008 financial crisis gave the SEC more power to monitor hedge funds and other private fund advisers. But the legislation also allowed family offices to continue to be excluded from the Advisers Act if they are "wholly owned" and "exclusively controlled" by family clients.
There could be pressure to change that rule after the blow-up of Archegos, which has rippled across markets.
"I think the marketplace is entitled to understand what positions they have and what they're doing," Doug Cifu, the CEO of Virtu Financial, said Monday in a Bloomberg TV interview.
Watch this space: Greater regulation of hedge funds is already being discussed after the huge run-up in GameStop (GME) shares earlier this year slammed Melvin Capital.
Hedge fund activity is on the agenda when Treasury Secretary Janet Yellen presides over a meeting of the Financial Stability Oversight Council on Wednesday. Thanks to Archegos, perhaps family offices should be, too.