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SEC Active Against Fraudulent Hedge Funds

Carla Johnson, Investors Offshore, London

02 April 2002

Paul Roye, director of investment management for the Securities and Exchange Commission, told a conference of mutual-fund industry executives in Orlando, Florida that the SEC has had to prosecute too many hedge-fund fraud cases and is actively monitoring developments in the industry.

"As hedge-fund assets have grown we have also seen an unfortunate growth in hedge-fund-related fraud," the director said in Monday's speech, which has been posted on the SEC's Web site. The commission has had to bring far too many hedge-fund-fraud cases in circumstances where the losses to investors have been substantial, he said.

Last year, Mr. Roye warned that hedge funds weren't ideal pension-fund investments, calling the proliferation of cases the SEC had brought against unregulated funds at that point a "miniboom."

Hedge funds, which can't be marketed widely to retail investors, are free from many of the regulatory constraints mutual funds face on shorting stock, borrowing money and moving funds into cash. This ability to hedge against market risk has allowed many managers to outperform the stock market during the past couple of years, attracting many first-time investors.

The $500 billion industry took in $31 billion of new money last year, attracting some unscrupulous operators along with a lot of new and unskilled investors. The flood of new money has meant that many of the biggest and most successful hedge funds are closing their doors to new investors, so that there is an increased temptation for investors to invest in less-established managers without carrying out adequate due diligence.

Some of the more notable cases of hedge-fund fraud the SEC has prosecuted in the past 18 months include those of Michael Berger, who pleaded guilty in November to covering up more than $400 million in losses from investors in his Manhattan Investment Fund, and Mark Yagalla, who was fined $32 million in February for plundering Ashbury Capital Partners.

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