WEDNESDAY, JANUARY 22, 2003 4:57 PM - Reuters U.S. Company News
By Svea Herbst-Bayliss
BOSTON, Jan 22 (Reuters) - U.S. financial regulators are making a big splash in the hedge fund industry with a probe that could sour investors on certain funds and signal that managers' freewheeling days are coming to an end.
New York Attorney General Eliot Spitzer is working alongside the Securities and Exchange Commission to determine if some hedge funds broke securities laws by publishing research on the Internet.
News of the investigation comes only weeks after Wall Street firms were fined for pumping up stock prices with phony research and it has set the $600 billion hedge fund industry abuzz at a time its managers are wooing Main Street clients.
Companies like bond insurer MBIA Inc. (MBI) and Federal Agricultural Mortgage Corp. (AGM) turned to regulators, saying that hedge funds like Gotham Partners Management Co., Aquamarine Fund Inc. and Tilson Capital Partners had published misleading research reports intended to push their stock price down.
Hedge funds differ from mutual funds by being able to bet against a company's future by borrowing its stock only to sell it and hope to replace the borrowed stock at a lower price. Last year, so-called short-sellers were among the most successful hedge fund managers, cashing in on the market's decline.
"We contacted the SEC and gave them the names of several hedge funds and now we are waiting to see what will happen. We hope the SEC and the attorney general take the appropriate steps and get things done," said Jerome Oslick, general counsel at Farmer Mac.
It may take months for attorneys to sort through the documents they are requesting from these funds, and lawyers say it is anyone's best guess on what will happen next.
THE NEW WORLD
Lawyers say selling short and talking about it is not illegal even though it is unusual for hedge funds, which aren't permitted to advertise through newspaper ads or even on public Web sites.
As the probe drags on, hedge fund industry experts say one thing may change very quickly -- investors like pension funds could start to steer away from short sellers.
Last year, some short sellers were heralded as heroes for having asked tough questions before Enron Corp. (ENRNQ) collapsed. Now many are seen as heartless villains who pounce on companies to drive their share prices down.
"The world of short sellers boils down to the pros, the wildmen, and the amateurs. The talent hasn't kept up and the short side is where the tale gets told," said Tom Wright, a spokesman for Bulldog Capital Management, which runs the short-biased Dancing Bear fund.
While mutual funds can lose only the amount of money investors put in, hedge funds can lose an almost limitless amount if the market turns against them.
And this makes investment committees very nervous.
"This is going to drive home the point that you can't just invest with people you meet at cocktail parties. You need to put your money with mature adults who know what they are doing," said one investor who chose not to put money with Gotham when its managers came calling.
The founding partners at some of the funds being probed started off shortly after graduating from Harvard Business School with money from former professors.
More far reaching, this probe might also prompt the SEC to speed up a review of the industry it started last summer.
At the moment, hedge funds are largely exempt from regulations because they are private partnerships with generally fewer than 100 wealthy investors. That may change.
Funds may be asked to register as investment advisers so regulators can audit them regularly or they may be asked to simply file information about themselves with regulators.
"I don't think anyone is saying all hedge funds should be as regulated as mutual funds. But there is a general feeling that hedge funds do need more regulation and the SEC has its antennae up about that," said Geoffrey Kenyon, partner at Boston-based law firm Goodwin Procter.
Market Data 
Markets 
AI
