SEC Issues Hedge Fund Investor Warning

February 12, 2003 ( - With government data showing an uptick in fraud actions against hedge funds, US regulators are warning investors of the potential dangers in hedge fund investing.

With its several-month old hedge fund probe continuing, the US Securities and Exchange Commission (SEC) said in a statement that the “fact-finding investigation” has generated 12 hedge fund fraud cases in 2002 versus five or fewer in each year from 1998 to 2001, Reuters reported (See   SEC Widens Hedge Fund Probe ).

“We’re not telling people not to invest in hedge funds,” Susan Wyderko, director of the SEC’s Office of Investor Education and Assistance, told Reuters. “But it’s very important that investors understand the potential risks and potential returns that are possible with these investment vehicles.”

The SEC also posted a scam hedge fund pitch on the Internet promising 22% returns on investment from the fictional Guaranteed Returns Diversified Inc., based in the uncharted Wylshock Islands in the Indian Ocean. The bogus “Gotcha” Web pitch was intended “to show investors an example of a hedge fund fraud,” said the SEC.

The SEC’s hedge fund probe is multi-pronged, but one aspect focuses on “funds of hedge funds,” which gather the assets of small investors to get them in the high-stakes hedge fund game. The commission this summer began sending questionnaires to hedge fund managers asking how they trade and value their portfolios. SEC officials have also personally visited funds.

In the 1990s bull stock market, some hedge funds delivered stellar returns, aided by loose government oversight allowing them to invest in almost anything, unlike mutual funds. But the bear market caught up with the $550-billion hedge fund industry. However its reputation for huge profits lingers and has been helping it to reach down to lower income brackets to attract more middle-class investors. Hedge funds are investment pools favored by institutions and the super-rich. Unlike mutual funds, hedge funds generally are not registered with the SEC.