Regulators say few big hedge fund frauds, eye risk

Date: Monday, December 4, 2006
Author: Tom Burroughes, Reuters.com

LONDON, Dec 4 (Reuters) - The hedge fund industry has shown few signs of major fraud, but cases of wrongdoing may rise if more of these investment vehicles are sold to mass-market savers, international financial regulators said on Monday.

The sector does not appear to have high levels of dishonesty, but some national watchdogs fear risks of fraud could rise if these funds were to become more available to retail investors, the International Organisation of Securities Commissions (IOSCO) said in a report.

Hedge funds, traditionally a secretive industry domiciled in offshore tax havens such as the Cayman Islands, have come under growing scrutiny from central banks and regulators concerned about the sector's potential impact on financial stability.

Traditionally, hedge funds have been used only by wealthy individuals or institutions such as pension funds.

"The extent of fraud relating to hedge funds varies in the member jurisdictions ... the absolute number of fraud complaints is presently not high, although some regulators perceive a risk of greater fraud in the future as further retailisation occurs," the report said.

There have been a number of cases of alleged or proven fraud in the hedge fund sector. In late November, a former hedge fund manager, Michael Tom, was sentenced in Boston to three years probation for illegally earning $750,000 by trading information that a local bank applied to buy a rival firm.

IOSCO said it supported moves to establish "some common investor-protection principles where hedge funds or fund of hedge funds are offered to retail clients".

LEGAL DEFINITIONS

On some estimates, hedge funds hold up to $1.7 trillion in assets. They use techniques such as short-selling - profiting from falls in share prices - leverage and use of derivatives to make money in different market conditions.

The potential risks of highly-leveraged hedge fund activities came to light with the demise of U.S. hedge fund Long Term Capital Management, which suffered massive losses in 1998. The saga prompted a rescue operation led by the Federal Reserve and major banks.

The IOSCO report drew back from making major recommendations. It concluded that there was no formal legal definition of a hedge fund in any of the major jurisdictions it surveyed. Few countries said there have been major shifts of hedge funds towards the mass retail saving market, IOSCO said.

In most of the IOSCO member countries, watchdogs are regulating hedge fund advisers or plan to do so.

In late October, the European Central Bank raised the prospect of tougher oversight for hedge funds.

ECB President Jean-Claude Trichet said there were potential risks for financial stability stemming from hedge funds and from their rapidly growing presence in the global system, although he also said they often improved the flow of money in financial markets and gave investors more choice.