In Focus

March 19, 2007

edge funds seem to be everywhere, with $1.4 trillion in assets! Yet they remain unregulated, occasionally "blow-up", lack transparency and arguably produce only mediocre returns - 6.5% according to some estimates - accounting for the asset based and performance based fees ("2 and 20") that hedge fund managers reap.

Two recent news stories indicate new directions (one good, one bad) that hedge fund investors should note. First, the good news. The hedge fund industry has begun to react to hedge fund implosions (like Amaranth Advisers last year) by offering a hedge fund "managed account." These managed accounts essentially are segregated portfolios that a hedge fund manager directs, and permit investors to view the hedge fund holdings, leveraged positions and net asset values. While hedge fund managers normally detest transparency, the collective persuasive powers of large institutional investors have convinced at least some hedge fund managers to forego their cherished secrecy and independence.

The bad news story relates to a middle-tier independent brokerage firm known as First Allied Securities. First Allied Securities is capitalizing on the hedge fund bonanza in a different way than most of its rivals. The firm is offering its financial advisers the opportunity to start and manage their own hedge funds. To be fair, First Allied Securities officials recognize that they must conduct due diligence and properly monitor the hedge fund activities. But the news sends shivers down my spine, having litigated many such actions against financial advisers who abandoned promises of conservative strategies, instead turning into cowboys, spiraling out of control, and causing investors millions of dollars in losses, all while purportedly under the watchful eye of the financial services firm.

First Allied Securities claims that it simply is responding to investor requests for performance based fees, and broke requests for products to attract high new worth investors. Only time will tell how this clever marketing story ends. If history is any guide, it won't end well for investors.

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James J. Eccleston is a securities attorney, representing customers as well as brokers and brokerage firms nationwide in arbitration, litigation and regulatory matters. He maintains an informative website at www.FinancialCounsel.com. He is an equity partner with Shaheen, Novoselsky, Staat, Filipowski & Eccleston, and can be reached at 312-621-4400.