U.S. lawyers busy as hedge funds face scrutiny

NEW YORK/BOSTON, July 25 (Reuters) - It's turning into a busy summer for U.S. lawyers who advise hedge funds as the industry faces growing questions about potentially manipulative trading and regulators are knocking at fund managers' doors.

With the markets in turmoil, the loosely regulated sector is under increasing scrutiny. The U.S. Securities and Exchange Commission recently sent subpoenas to more than 50 firms regarding possibly abusive trading activity.

Some funds have sought advice to be sure they are complying with the rules, which include new limits on short-selling.

Others are calling for help to set up new funds as managers try to find ways to make money in a rough market.

On the regulatory front, hedge funds want to head off any potential problems, said John Brunjes, a partner in the private investment funds practice at law firm Bracewell & Giuliani.

"Our clients are saying, 'let us tell you what we are doing. Do we have a problem? Are we headed down a road that may create a problem?'" he said. "That kind of call is coming in with greater frequency."

The "better-managed funds that understand they can't be fast and loose around these kinds of developments in the marketplace are the ones that seem to be picking up the phone and calling," said Brunjes, who is based in Connecticut, where many hedge funds also have their headquarters.

The indictment in June of two former portfolio managers at Bear Stearns for allegedly deceiving clients about the health of two mortgage-linked hedge funds they ran has reverberated through the industry. The two men have pleaded not guilty.

Todd Harrison, a former federal prosecutor who now is a partner at Patton Boggs in New York, said that in the past "the normal case would have been to hire outside lawyers after people hear that they have a problem."

"(But) looking at the Bear Stearns situation, people are definitely more concerned now and want an outside party to conduct some investigations to tell them if they have a problem. People absolutely want to get ahead of this."

The SEC has sent subpoenas to more than four dozen hedge funds and brokerages requesting information about trading in shares of Bear Stearns, which agreed to an emergency buyout by JPMorgan Chase & Co (JPM.N) in March.

It is also looking into trading in shares of Lehman Brothers Holdings Inc LEH.N, which have fallen amid rumors about its financial health.

OFF LIMITS

At the same time, hedge funds are dealing with an emergency SEC decision to limit short-selling in financial stocks -- an order that commission Chairman Christopher Cox plans to propose expanding to the broader market.

Hedge funds can use a variety of trading techniques, including short-selling, that are generally off limits to mutual funds and these have helped the $1.9 trillion industry deliver strong returns in recent years.

Regulators have also announced that they will examine whether both broker-dealers and investment advisers have controls in place to prevent market manipulation.

Ralph Siciliano, a partner at law firm Tannenbaum Helpern Syracuse & Hirschtritt LLP, said he expects the SEC to increase requests for information about hedge fund practices.

This isn't the first time the agency has done such an industry-wide sweep. For example, it has previously looked at hedge funds that were active players in the market for PIPEs, or private investments in public equity, he said.

"Judging from the past, I think there's going to be a flurry of these kinds of requests that are going to require the firms to respond in consultation with their lawyers," said Siciliano, who focuses on compliance issues.

The SEC's current focus on the spread of false rumors is something that lawyers will watch closely, he said.

"Hedge funds do engage in a lot of shortselling, and that's a very legitimate part of many strategies," Siciliano said.

"The one area that I think the funds and their lawyers want to watch very closely is that the regulators do not automatically assume that because a hedge fund is engaged in shortselling that it has spread rumors about the company."

Other lawyers say they have not had many new inquiries from clients on compliance issues in the wake of the SEC subpoenas or new short-selling rules.

Instead, these attorneys are busy for other reasons, such as counseling funds on setting up new products, including those that invest in distressed assets, as portfolio managers seek to improve performance.

"We have a number of clients that are looking to launch new strategies," said Olga Gutman, a partner at law firm Simpson Thacher & Bartlett LLP in New York.

Clients are trying to "be creative" in launching or restructuring their products, she said. (Reporting by Martha Graybow and Svea Herbst-Baylis; Editing by Ted Kerr)