News & Events

Hedge Fund Misconduct and Due Diligence: Protecting Yourself

In the last five years, there has been a spate of high-profile enforcement actions against hedge funds by the US Securities and Exchange Commission (“SEC” or “Commission”) as well as other federal and state regulators and even prosecutors.  Indeed, the SEC cited hedge fund fraud as a justification for requiring hedge fund advisors to register with the Commission2 .  As with everything else, there is both good news and bad news.  The bad news, according to the SEC, is that “[i]n recent years, the Commission has instituted a significant number of actions alleging hedge fund fraud3 .”  The good news, also according to the SEC, is that “there is no evidence indicating that hedge funds or their advisors engage disproportionately in fraudulent activity4 .”  The latter is particularly true when you consider the magnitude of frauds that occurred outside the hedge fund industry – such as Enron, Adelphia and WorldCom – in which investors lost billions of dollars5 .                          In light of the SEC’s focus on hedge fund misconduct, and in light of the handful of headline-grabbing hedge fund frauds, it is important for funds of funds, institutional investors, and other investors to understand how best to avoid becoming a victim of the relatively few instances of hedge fund fraud.  This paper aims to highlight some of the more spectacular instances of hedge fund misconduct cases and provide ways in which investors can protect themselves from fraud.

The Statistics

Although the SEC claims hedge fund fraud is on the rise, and certain statistics can be read in support of that assertion, we must be mindful of what former British Prime Minister Benjamin Disraeli said about lies: “There are three kinds of lies: lies, damn lies and statistics.”  Just looking at the statistics with regard to instances of hedge fund misconduct, one could make out a case that it is increasing.  For example, as seen in Chart 1, although the level of such cases remained stable between 2000 and 2003, there was an increase in 2004 and again in 2005.


Viewing the numbers this way supports the SEC’s view.  It is important to note, however, that the statistics are based on reported enforcement actions and are recorded for the year in which the enforcement action was filed.  Because many of these cases were ongoing, the numbers may overstate, or alternatively understate, the actual incidence of fraud in any given year.  Moreover, very few of these cases were litigated, perhaps because the amounts at stake were relatively small.  If litigated, we may find lower numbers since there may have been no misconduct at all in many of these situations.

Another way to view the statistics is by examining investor losses caused by hedge fund misconduct (see Chart 2).  Here too, the numbers are subject to challenge.  Since many fund managers did not contest the enforcement actions, all we are left with is the government’s allegation of losses.  In addition, the numbers are skewed by a few frauds of massive proportions.  For example, investors in the Manhattan Investment Fund lost US$400 million in a fraudulent scheme that went on for years but was reported in 2000; likewise, Beacon Hill investors lost over US$300 million in an ongoing scheme reported in 2002.

Finally, you must view the statistics in the context of the overall industry, which has grown by leaps and bounds.  Although there is no one authoritative source providing information on the growth of the hedge fund industry, recent reports indicate that there were between 4,800 and 6,500 hedge funds in existence in 2000 with anywhere from US$408 million to US$520 million under management6 .  By 2005, there were approximately 8,000 hedge funds with over a trillion dollars under management7 .

Recent SEC Enforcement Actions

The SEC brought 8 enforcement actions against hedge funds in 2003, 12 in 2004, and 30 in 2005.  In addition, other regulators in the United States (i.e., the state securities regulators and attorneys general, US Attorneys Offices, New York Stock Exchange, National Association of Securities Dealers, Commodity Futures Trading Commission  (“CFTC”) … and the list goes on) have brought other enforcement actions relating to hedge funds.  Many of these cases were relatively small matters, but there were a number of more notorious enforcement actions.  The more significant ones are highlighted below.            

  1. Bayou8

    From 1996 to 2005, investors poured over US$450 million into the Bayou hedge funds while its managers, Samuel Israel III and Daniel E. Marino, claimed the funds were generating substantial gains.  Meanwhile, to conceal multi-million dollar trading losses, Israel and Marino distributed phony account statements and performance summaries, and forged financial statements that were “independently audited” by a sham accounting firm created by Marino.  Despite never having generated a year-end profit, Israel and Marino continued to withdraw “incentive fees” from the funds and maintained lavish lifestyles.  By mid-2004, Israel and Marino abandoned their investment strategy and transferred the funds’ remaining US$150 million to Israel and other non-Bayou-related entities for an investment scheme reportedly intended to convert US$100 million into US$7.1 billion involving a “prime bank” scam.  In May 2005, while investigating an unrelated financial fraud, Arizona officials noticed the US$100 million being moved from account to account, became suspicious, and uncovered the massive Bayou fraud.  Both the SEC and the CFTC brought actions against Israel, Marino and the Bayou entities.  Marino eventually confessed to the fraudulent scheme in a “suicide” note.  And Marino and Israel later pled guilty to federal criminal charges.  They are now awaiting sentencing.  The problem, of course, is that most of the hundreds of millions of dollars that investors lost in Bayou disappeared because Israel and Marino made bad trading decisions and lost the money in the market.  Although it may take some time to sort out the Bayou fraud and recover whatever money is left, investors are likely to still be out hundreds of millions of dollars at the end of the day.

  2. Wood River9

    John Whittier ran the US$265 million hedge fund Wood River Partners LP.  Whittier promised investors the fund would be broadly diversified and closely watched by an auditor.  In fact, Whittier failed to have any audits conducted, had no independent administrator to review the fund’s holdings and valuations, kept the fund’s portfolio secret from all but a few employees, and failed to make regulatory filings that would have disclosed its highly concentrated holdings in one small-cap stock called Endwave.  The fund’s position in Endwave was so enormous that at one point the fund owned over 45% of Endwave’s outstanding stock.  By July 2005, the Endwave stock accounted for more than 65% of the fund’s assets under management.  Whittier also launched a new offshore hedge fund with the same promises of portfolio diversification, but he again went on to place the majority of its assets into Endwave without telling investors.  Things began to unravel when Whittier was unable to meet redemption requests and when the price of Endwave’s stock plunged.  This precipitated margin calls, which Wood River could not meet, and which resulted in further (forced) sales of Endwave stock to meet the margin calls which caused the stock to drop even further.  An SEC enforcement action followed soon thereafter and a receiver was appointed.                          Wood River faces many problems as a result of Whittier’s misconduct.  First, Whittier’s surreptitious accumulations of Endwave stock violated Section 13(d) of the Securities Exchange Act of 1934 (the “Exchange Act”), which requires the filing of disclosure schedules with the SEC anytime a person or entity becomes a beneficial owner of 5% or more of a class of publicly-traded securities.  An amendment must also be filed anytime there is a material change in the stock ownership, which presumptively occurs when there is an increase or decrease in beneficial ownership by 1%.  In addition, officers, directors and beneficial owners of 10% or more of a company’s securities are required by Section 16(a) of the Exchange Act to file a Form 3 disclosure.  A Form 4 disclosure must then be filed to report every purchase and sale that occurs beyond that 10% threshold.  Because Wood River bought and sold Endwave stock after becoming 10% holders, under Section 16(b) of the Securities Exchange Act, they are required to disgorge any profits earned on trades made within six months of each other while above the 10% threshold.  Since the statute calls for strict liability with regard to disgorgement, Wood River may be subject to substantial disgorgement to Endwave.  The receiver must now negotiate with Endwave to deal with these §16(b) liabilities and ensure that Wood River’s large Endwave position does not trigger Endwave’s poison pill, which may dilute Wood River’s shares substantially.  The receiver must also determine who Wood River may have claims against, such as Whittier, its employees or its service providers, then distribute whatever assets are left to creditors and investors.

  3. Durus Life Sciences Funds10

    From 2001 to July 2003, Scott Sacane (through Durus Capital Management LLC, Durus Capital Management (NA)) made regular, substantial and undisclosed purchases of Esperion Therapeutics Inc and Aksys Ltd for the benefit of the Durus Life Sciences Funds, a master-feeder hedge fund complex that they managed.  By July 2003, the undisclosed purchases resulted in the hedge funds controlling approximately 33% of Esperion’s outstanding stock and approximately 78% of Aksys’ outstanding stock.  Sacane also sold and shorted stock of both companies without disclosing the funds' ownership position.  Sacane also allegedly lied to Esperion and Aksys executives about the stock purchases and lied to his former employer about purported non-public information he possessed in order to prevent that former employer from selling stock of the companies while Sacane was accumulating the stock in the Durus portfolio.  In July 2003, Durus announced the highly concentrated positions in Aksys and Esperion.  Sacane acknowledged his wrongdoing and eventually pled guilty to federal criminal charges.  Because Durus failed to file required disclosure schedules under Sections 13(d) and 16(a) of the Exchange Act, and generated significant short-swing profits in violation of Section 16(b), the Durus Funds were faced with tens of millions of dollars in liabilities because of Sacane’s misconduct.  In addition, Sacane’s acquisitions risked triggering the poison pills of Aksys and Esperion (which would have severely diluted the value of the funds’ holdings in those stocks).  The SEC’s suit charges Sacane with purposefully manipulating stock in order to ensure incentive fees.  In addition, the Federal Trade Commission (“FTC”) fined Sacane for failure to file the required pre-merger notification forms under the Hart Scott Rodino Antitrust Improvements Act.  Notably, the SEC and FTC viewed the Durus funds and their investors as innocent victims of the wrongdoing and chose not to charge the funds themselves.  Investors have since organised themselves, taken over the funds’ Board of Directors and removed Sacane.  The investors also put in an independent monitor, negotiated the resolution of Section 16(b) liabilities with Aksys and Esperion, persuaded Aksys not to trigger its poison pill, and worked cooperatively with the SEC and the US Attorney’s Office to bring Sacane to justice.

  4. Philadelphia Alternative Asset Fund11

    In October 2002, Philadelphia Alternative Asset Management ("PAAM") and its president, Paul Eustace, began soliciting investments for a commodity trading pool and purported hedge fund called Philadelphia Alternative Asset Fund LP.  One participant who had invested US$680,000 in the pool received statements reflecting that his account had increased in value to over US$1 million.  Eustace presented another prospective pool participant with a chart purportedly reflecting actual trading results with a cumulative percentage return of 25.38%.  But, according to the CFTC, the pool never even traded futures or options as investors had been told.  Eustace later claimed that the statements were based on hypothetical trading only.  In late 2004, PAAM began operating two more commodity pools, Philadelphia Alternative Asset Fund Ltd and Philadelphia Alternative Asset Feeder Fund LLC, to exclusively trade exchange-traded futures and options.  These pools collected over US$230 million from investors.  However, although the PAAM website claimed profitable trading results, the pools lost over US$140 million in trading.  The CFTC’s suit is pending.

Mutual Fund Market Timing Investigations

Beginning in September 2003, New York’s Attorney General (“NYAG”), Eliot Spitzer, announced that he had uncovered widespread misconduct in the mutual fund industry, which involved hedge funds and other sophisticated investors engaging in “market timing” and “late trading” in US open end mutual funds12 .  “Market timing” involves short-term trading in mutual funds, while “late trading” involves purchasing mutual fund shares after 4pm and receiving the price calculated that day (often “as of” 4pm).  Authorities have claimed that late trading is illegal and can result in criminal charges.  Although market timing is legal, the regulators have taken the position that it is illegal to use deceptive practices to disguise market timing from mutual funds.  The NYAG, together with the SEC, US Attorney’s Offices and various other federal and state regulators then launched major investigations of the mutual fund industry.   As a result, of these investigations, 18 mutual funds, 19 brokerage firms and 4 investors entered into settlements with the regulators, amounting to US$3.6 billion in the aggregate13.  In most instances, the party that entered into the settlement neither admitted nor denied wrongdoing.  Theodore Sihpol, III, a former broker at Bank of America, was a notable exception.  The NYAG brought criminal charges against Siphol relating to late trading early in the investigations.  Refusing to capitulate to pressure from the NYAG, Sihpol pled not guilty and went to trial.  Ultimately, he was acquitted by a jury of most of the charges.  Spitzer later dropped the remaining charges and Sihpol entered into a civil settlement with the SEC.

Regulation M Cases

Rule 105 of Regulation M is an anti-manipulation rule designed to prevent short selling in anticipation of an underwritten public offering.  The rule prohibits covering a short sale with securities obtained in a follow-on offering if the short sale occurred within five business days before the pricing of that offering.  It is a prophylactic rule and prohibits the conduct irrespective of intent.  The SEC interpreted the rule as also prohibiting “sham transactions” in which funds create and cover short positions in violation of the rule, and then, in order to create the appearance of compliance with the rule, engage in further transactions in which “there is no legitimate economic purpose or substance to the contemporaneous purchase and sale, no genuine change in beneficial ownership, and/or little or no market risk14 .”

In May 2005, the SEC brought enforcement actions against three hedge fund advisors, Galleon Management LP, Oaktree Capital Management LLC and DB Investment Managers Inc, for alleged manipulative short selling in violation of Rule 10515 .  According to the SEC, both Galleon and Oaktree also executed sham transactions. 

As the SEC charged, Galleon routinely created boxed positions by establishing long positions with shares purchased in an offering while simultaneously maintaining a pre-pricing short position in the securities of the same issuer.  Galleon then “collapsed the box” through the use of “riskless,” offsetting journal entries or executed unwinding transactions in the open market through different brokers, with little risk to itself.  Galleon realised profits of US$1,040,882 from these transactions.  Similarly, Oaktree realised profits of US$169,773 by creating boxed positions and then crossing the long and short position against the other, resulting in a flat position in the issuer’s stock.  According to the SEC, these cross transactions served no economic purpose and presented no market risk.  Finally, DB Investment Managers violated Rule 105 by submitting a tiered indication of interest to the lead underwriter on the pricing date for each offering, but prior to any sale transactions in the relevant securities, and then selling short shares of the issuer, in amounts which represented a portion of its anticipated allocation in the deal.  DB Investment Managers realised profits of US$15,858.  The SEC ordered all three advisors to disgorge the ill-gotten profits, pay civil penalties, and adopt and implement written policies and procedures to prevent such violations in the future.

PIPEs Investigations

A “PIPE”, a “private investment in public equity”, is a means by which US publicly-traded companies can raise money by selling unregistered securities to sophisticated investors through a private placement.  The benefit of a PIPE is that the companies can raise money quickly and without the expense of registering those securities prior to the transaction closing. 

The SEC is currently in the midst of a long-running investigation into PIPE transactions amid allegations of market manipulation and insider trading.  The investigation, which also involves the US Attorney’s Office and the NASD, began when a mutual fund that was trading securities noticed significant price erosion in certain issuers’ securities in the days immediately preceding announcement by the companies that they had sold securities in a PIPE.  Suspecting misconduct, the mutual fund brought the matter to the SEC.  The SEC’s Office of Compliance Inspections and Examinations (“OCIE”) contacted placement agents, brokers and bankers who had been hired by companies to put together certain PIPEs transactions.  As part of this sweep, OCIE sought information about who knew about the deals, what they knew and when they knew it.  OCIE found that a number of institutional investors, including hedge funds, had shorted companies’ stock before the announcement of PIPE transactions.  OCIE turned the matter over to the SEC’s Division of Enforcement, who then opened a wide-ranging investigation which has included interviewing witnesses, taking formal testimony and subpoenaing documents from issuers, placement agents, and institutional investors, including hedge funds.  And, according to published reports, the SEC has also begun issuing Wells Notices16 .

The SEC, along with other regulators, have already brought civil actions in connection with the PIPEs investigation, and the US Attorney’s Offices too are investigating – and prosecuting – criminal misconduct in this marketplace.  For example, in 2003, the SEC filed an action against Rhino Advisors Inc and its president, Thomas Badian, for their alleged manipulative short selling of Sedona Corporation stock17 .  Sedona had entered into a purchase agreement with Amro International SA, one of Rhino’s clients, for a convertible debenture.  Under the agreement, Amro had the right to convert the debenture into Sedona common stock at a discount to the market price during a five-day period prior to the conversion; hence, the lower the price of the Sedona shares, the greater the number of Sedona shares Amro stood to receive. The agreement also provided that Amro would not engage in short selling shares of Sedona stock while the debenture remained issued and outstanding.  Nevertheless, in order to increase Amro’s interest in the debenture, Rhino engaged in substantial short selling of Sedona stock, thereby driving Sedona’s stock price down.  Amro then exercised its conversion rights and received more than its “fair share” of Sedona stock.  Moreover, in an effort to conceal Amro’s involvement in the scheme, Rhino then engaged in wash sales and matched orders to cover the short positions.  Rhino and Badian settled with the SEC and agreed to, among other things, a civil penalty of US$1 million.  Badian was also indicted by federal prosecutors in December 2003.

Most recently, in May 2005, the SEC and NASD took action against Hilary Shane, alleging insider trading in connection with her involvement in a PIPE offering by CompuDyne Corporation18 .  At the time, Shane managed the portfolios of, and provided investment advice to, certain hedge funds.  When approached to participate in the PIPE offering, Shane agreed to keep information about the PIPE offering confidential.  As part of the offering, Shane also agreed to purchase shares for her personal account and for the account of one of the hedge funds she managed, for the below-market price of US$12 per share.  Expecting that announcement of the PIPE would cause a fall in the price of CompuDyne stock, Shane began short selling CompuDyne stock – in direct violation of her promise not to do so – until she had sold short the same number of shares allocated to her in the PIPE offering.  As a result, she reaped US$296,785 in ill-gotten gains for herself and for a hedge fund that she managed, and she made an additional profit of US$356,153 through the unregistered sale of the CompuDyne securities.  Shane settled with the SEC and NASD by, among other things, agreeing to pay US$1.45 million and accepting a permanent injunction against associating with NASD-registered firms.

Finally, in April 2005, the SEC charged rogue trader Guillaume Pollet with insider trading and manipulative short selling in connection with a number of PIPE transactions.  Pollet locked in US$4 million in trading profits from his short selling of shares of PIPEs issuers after receiving non-public information about the PIPE deals.  In some instances, Pollet’s employer acted as the issuers’ investment banker and represented that they would not engage in such short selling prior to the close of the PIPE.  The SEC’s case against Pollet is pending.  The US Attorney’s Office indicted Pollet, who pled guilty and was recently sentenced to jail.


In addition, there are always instances where the SEC is investigating specific hedge funds as well as other types of investors for insider trading, market manipulation, and other securities laws violations.  Finally, the SEC, as well as the NASD and the NYSE, have become very focused on marketing practices with regard to how hedge fund interests are sold to investors.  For example, in 2003 the NASD issued a Notice to Members reiterating its marketing standards for hedge funds19 .  And in its report on the hedge fund industry, the SEC raised issues of whether those selling hedge fund interests are required to register as representatives of a broker-dealer and whether certain hedge fund marketing practices comply with private offering requirements20

How Investors Can – and Should – Protect Themselves

In light of the recent – yet relatively few – dramatic hedge fund collapses, naturally, the next question is: how can I avoid becoming a victim of fraud?  The answer:  due diligence, due diligence and more due diligence.

It is important for investors to conduct detailed due diligence before investing in a hedge fund, any hedge fund.  And, of course, there is no one-size-fits-all approach to due diligence.  Due diligence must be tailored to the specific hedge funds you are considering.  The importance of truly analysing and fully understanding the results of due diligence cannot be overstated.  All too many investors have been burned over the years by following a “check list mentality” to due diligence, asking many of the right questions but not drilling down and fully understanding the answers.

There are many tools you can utilise when conducting due diligence.  For example, read the fund’s documents, including the offering memorandum and partnership agreement, LLC agreement or articles of association.  Read any other juridical documents about the fund that you can get your hands on, including the administration agreement and the portfolio management agreement.  Read the marketing materials.  Examine the fund’s performance results and scrutinize its financial statements.  Now all this may seem obvious, but many investors only read some – but not all – of these documents, or skim through them rather than studying them.  This can create an expectation gap, such as when the investor expects the administrator to independently value the portfolio every month as part of calculating the NAV but the portfolio management agreement makes clear that the administrator is not independently checking securities prices but rather accepting the manager’s valuations and simply using that information to calculate the NAV (ie all the administrator does is arithmetic).

You can also talk to the fund manager, chief compliance officer, general counsel, chief operating officer, portfolio managers and other key fund personnel.  Make sure that as a result of these meetings you truly understand the fund’s investment strategy.  Understanding the investment strategy and how it fits into the broader marketplace is essential to gaining a better understanding of your risk exposure.  Don’t be afraid to ask questions, especially the hard questions.  After all, it’s your money – or money you have fiduciary duties to protect.  If you don’t understand the investment strategy, then you should ask more questions or consider passing on the investment.         

In talking to the manager, reading the documents and looking at the fund’s performance results, always ask yourself:  “Is this too good to be true?”  If it sounds too good to be true, that may well be a sign that the manager is engaged in misconduct.  Take, for example, the Manhattan Investment Fund (“MIF”).  MIF’s manager, Michael Berger, operated this US$575 million hedge fund from 1996 to 1999.  In that time, Berger told investors he would make money for them by shorting technology and Internet stocks based on his belief that those sectors were dramatically overvalued.  And he did.  The problem was he was doing so during an unprecedented boom in the market where stock prices soared in virtually every industry, especially in the technology and Internet sectors.  And yet at a time when the technology sector was booming, Berger was telling investors he was making money by shorting these stocks.  This simply did not make sense.  It was too good to be true.  And yet many high-quality institutional investors and funds of funds literally threw money at Berger, investing hundreds of millions of dollars in MIF, while being told that the fund was making money by shorting technology stock during a boom in the technology sector.  Ultimately, many of them lost virtually all of their investments for lack of due diligence.

Another good source of due diligence is the fund administrator, who can help you gain an understanding of how the portfolio is priced.  A number of the larger, headline-grabbing hedge fund frauds, involved portfolio mispricing21 .  In talking to the administrator, find out what sources are being used to set prices and whether the administrator is independently confirming the manager’s pricing or simply using the manager’s numbers.

Also, don’t be afraid to talk to the auditor.  Find out whether the fund produces audited financial statements.  If so, look at them.  And don’t just look at the numbers; read the footnotes carefully.  See if there were control deficiencies or other disclosures that might suggest a problem.  Simply having an auditor – even an independent auditor (unlike Bayou) – does not ensure that there is no misconduct.

Talk to the prime brokers as well.  In this day and age, most funds – even small ones – have more than one prime broker.  Find out who they are and whether they are independent.  Understand how the prime broker is reporting the results of trading and to whom.  For example, are the trading results given directly to the administrator?  Or to the manager, who then has the ability to falsify the results before giving them to the administrator?  Also get a sense of the amount of leverage the prime broker is providing to the manager.  In addition, talking to the prime broker may help you determine if the fund is holding concentrated positions, and if so, how concentrated.  This could help you avoid situations like Durus or Wood River, where the funds were tied up in a single, or a handful, of large holdings that later became illiquid.

In determining who the service providers are, also consider their reputations.  Are they high-quality firms, in which you can draw comfort?  Or are they people you’ve never heard of, in which case you’d want to do more due diligence?  Finally, recognise that the existence of an independent administrator, auditor and prime broker, all of whom are high quality, is still no guarantee against fraud.  Again, consider, for example, the Manhattan Investment Fund case where the fund manager generated fake account statements and sent them to the administrator and auditor, who were then persuaded to rely on the fake account statements rather than the accurate account statements they got directly from the prime broker

Of course, not every manager will let you talk to the administrator, auditor and/or prime brokers.  Or the manager may only do so if you sign a confidentiality agreement or permit the manager to participate in your discussions with the fund’s service providers.  Be sensitive to the fact that there may be good reasons for the manager to exercise caution about who can speak with the fund’s service providers as well as what can be discussed in order to protect the fund’s confidential information and trade secrets.

Also consider asking for references from the manager.  For example, talk to current investors.  Also talk to former investors who redeemed.  Ask whether the redemptions resulted from perceived problems in the fund, which might raise a red flag for you or resulted from innocuous reasons, such as the case of a fund of funds selling off one of its investments in order to generate cash for an investor redemption.

Finally, consider hiring a private investigator to perform a background check on the fund manager and key people within the management company.  You never know what you’re going to find until you look.


There have been some rather spectacular hedge fund frauds recently that caught the attention of regulators.  Remember that the regulators have much to do, and hedge fund investors are, by definition, sophisticated investors.  You cannot count on the SEC to protect you.  It’s your money and you must do something to protect yourself

This article was originally prepared as a paper given at the 7th Annual International Private Investment Funds Conference of the International Bar Association in London in March 2005 and is published with the kind permission of the IBA. Copyright International Bar Association 2006.

The paper was subsequently published in Hedge Funds Review magazine.


1 Harry S. Davis is a partner in the Litigation Department of Schulte Roth & Zabel LLP who concentrates on securities law litigation and regulatory investigations involving the financial services industry, including hedge funds, funds of funds, private equity funds, broker-dealers and other service providers to the private investment fund community as well as other types of complex commercial litigation. Sahar Shirazi is a litigation associate at Schulte Roth & Zabel LLP.

2 See Registration Under the Advisers Act of Certain Hedge Fund Advisers, Investment Advisers Act Release No 2333, File No S7-30-04 (2 December 2004).

3 Implications of the Growth of Hedge Funds, Staff Report to the United States Securities and Exchange Commission, pp 72-73 (September 2003).

4 Id.

5 See, eg, Penelope Patsuris, The Corporate Scandal Sheet, Forbes, August 2002, available at

6 See All About Hedge Funds Size of the Hedge Fund Universe, Van Hedge Fund Advisors International LLC, 2005, available at (accessed 1 December 2005); Hedge Fund Industry Growth, Hennessee Group LLC, January 2005, available at (accessed 6 February 2006).

7 See Campos, Roel.  Remarks before the SIA Hedge Fund Conference, 14 September 2005, available at (accessed 6 February 2006).

8 SEC v Israel, et al, Litigation Release No 19406 (29 September 2005); CFTC v Bayou Management LLC, et al, Press Release No 5121-05 (29 September 2005).

9 SEC v Wood River Capital Management LLC, et al, Litigation Release No. 19428 (13 October 2005).

10 SEC v Scott R. Sacane, et al, Litigation Release No 19424 (12 October 2005).

11 CFTC v Paul M Eustace, et al, Press Release 5091-05 (29 June 2005).

12 See 3 September 2003 Press Release, Office of the New York Attorney General Eliot Spitzer, State Investigation Reveals Mutual Fund Fraud.

13 The following mutual fund families entered into settlements with regulators: AIM Investments; Alliance Capital Management; Allianz Dresdner Asset Management of America LP (Pimco); Bank of America (Nations Funds); Bank One; Charles Schwab Corp; Federated Investors; FleetBoston Financial Corporation (Columbia Funds); Franklin Resources Inc;  Fremont Investment Advisors;  Invesco Funds Group; Janus Capital Group; Massachusetts Financial Services Co (MFS); Pilgrim Baxter & Associates; Putnam;  RS Investments; State Street Research & Management Co; and Strong Capital Management.  The following broker-dealers entered into settlements with regulators:  American Express; Brean Murray; Burnham Securities; D.A. Davidson & Co; Davenport & Company; Fiserv Securities Inc; H & R Block Financial Advisers, Inc; JB Oxford Holdings; Key Corp (McDonald Investments Inc); Legg Mason; Merrill Lynch; National Planning Corp; National Securities Corp; Paulson Capital; Sentinel Financial Services; SII Investments Inc; Southwest Securities; Stifel Nicolaus & Co; and TD Waterhouse Investor Services Inc.  In addition, the following investors have settled with regulators:  Daniel Calugar and Securities Brokerage Inc; Canary Capital Partners; Millennium Partners LP; and Veras Investment Partners.  Other entities that have settled with regulators include: Canadian Imperial Bank Corp (CIBC), a bank; Security Trust Co, a trust company; Conseco Inc, a variable annuity provider; and Jefferson Pilot Variable Corp, a variable annuity provider. 

14 Short Sales, Exchange Act Release No 50103 (7 September 2004).

15 SEC v Galleon Management, LP, Litigation Release No 19228 (19 May 2005); In the Matter of Oaktree Capital Management LLC, Securities Exchange Act Release No 51709, Investment Advisers Act Release No 2385 (19 May 2005);  In the Matter of DB Investment Managers Inc, Securities Exchange Act Release No 51707, Investment Advisers Act Release No. 2384 (19 May 2005).

16 A Wells Notice is issued when SEC staff members have reason to believe the recipient has violated federal securities laws.  It gives notice that the staff plans to ask the Commission to file a complaint (since only the Commission itself has the power to bring suit).  The recipient of a Wells Notice has an opportunity to prepare a Wells Memorandum, which is a legal brief explaining why that person or entity believes they have not violated federal securities laws and bringing to the Commission’s attention any other information the recipient wants the Commission to know before deciding whether to authorise the filing of an enforcement action.  The Commission then considers the Wells Memorandum along with the SEC staff’s comments in deciding whether or not to bring an enforcement action.

17 SEC v Rhino Advisors Inc and Thomas Badian, Litigation Release No 18003 (27 February 2003).

18 SEC v Hilary L. Shane, Litigation Release No 19227 (18 May 2005).

19 NASD Reminds Members of Obligations When Selling Hedge Funds, NASD Notice to Members 03-07 (February 2003).

20 Implications of the Growth of Hedge Funds, Staff Report to the United States Securities and Exchange Commission (September 2003).

21 See, eg, SEC v Israel, et al, Litigation Release No 19406 (29 September 2005); SEC v Beacon Hill Asset Management LLC, et al, Litigation Release No 17831 (7 November 2002); SEC v Michael W Berger, et al, Litigation Release 16412 (19 January 2000).

22 See SEC v Israel, et al, Litigation Release No 19406 (29 September 2005).