Fraudulent Hedge Funds

A hedge fund may be regarded as an extremely hard-core mutual fund. Like a mutual fund, a hedge fund is a pool of money from multiple investors that is invested in diverse ventures in the hope of turning a profit. Here, however, the similarity ends. Compared to mutual funds, hedge funds are the James Bonds of the marketplace. They are relatively unfettered by government regulation, and they play bigger games, take bigger risks, possess an air of sophistication, use unorthodox methods, and have the power to capture the public imagination in a way that their lesser counterparts have difficulty approaching.

The first hedge fund was started in 1949 by Alfred Winslow Jones, an Australian-American sociologist and financial magazine editor who decided to try his hand at investing. His unique investment strategy was to buy stocks with half his investors’ money, and sell short with the other half. Short selling a stock is betting that it will go down in value rather than up. By buying some stocks while simultaneously short selling others, Jones was in effect hedging his bets (hence the name.) If the entire market experienced a downturn, Jones could at least recoup some of his losses or ideally turn a profit. With hedge funds, the skill and luck of the manager became the only determining factor in how much money could be made, irrespective of the state of the market.

Today, hedge funds may employ a variety of strategies. The term has changed in meaning, and hedge funds are now, somewhat ironically and paradoxically, characterized by higher risk. Hedge fund operators use innovative strategies, sometimes inventing and refining bold new investment techniques. They frequently invest heavily in their own fund. If successful, they may compensate themselves extremely well, taking a large portion of the profits for their personal fortune.

The term “hedge fund” has no official definition, but the typical hedge fund is a private investment portfolio catering to wealthy, adventurous, sophisticated individuals who are not afraid to risk losing their investment for a chance to turn staggering profits. Hedge funds do not advertise or offer their services publicly, and the price to buy into them is very great, often in the neighborhood of one million dollars. Hedge funds are typically limited to small numbers of investors, with fewer than a hundred in each one.

Because hedge funds are generally organized as a partnership (rather than as a corporation), they traditionally have operated outside government control, and were not required to register with the Securities and Exchange Commission (SEC) or adhere to most of its regulations. Very recently, this has changed. Starting in early 2006, hedge funds of over 25 million dollars will be required to register with the SEC.