Hedge funds fear new rules to rattle their business

By Svea Herbst-Bayliss

BOSTON (Reuters) - The financial crisis is getting personal for U.S. hedge-fund managers.

Many say they fear their business could be badly hurt or even destroyed by an immediate 10-day ban on short sales aimed at preventing investors from making bets on stock declines -- a common strategy in the $1.9 trillion hedge-fund industry.

After a week of massive turmoil on Wall Street, the Securities and Exchange Commission put in its most restrictive rule targeting the loosely regulated hedge-fund industry on Friday by also demanding new insight into their secretive world.

Now money managers will have to say what stocks they are shorting, or betting will fall. Previously, they only had to disclose their long positions four times a year.

The SEC's ban on short sales of around 800 financial stocks could be extended but not by longer than 30 days.

"It is like being asked to give away your magic recipe," said Philippe Bonnefoy, who invests in hedge funds as chairman of the asset allocation committee at Geneva-based Cedar Partners. "The industry is alive, but badly burned."

Shorting is a technique hedge-fund managers often use to offset exposure in their portfolios or to draw attention to stubborn problems at a company such as Lehman Brothers Holdings, which filed for bankruptcy protection on Monday after falling victim to the year-old credit crunch.

Because hedge funds often operate in secret to keep competitors at bay, managers are frequently called vultures who profit by destroying good companies. New York Attorney General Andrew Cuomo likened some to "looters after a hurricane."

Cuomo has opened investigations into short sellers who he believes are peddling rumors to manipulate Wall Street.

Now, as regulators struggle to prop up the teetering U.S. financial system, hedge funds are also being blamed for exacerbating the worst financial disaster since the Great Depression.

"In an election year, there is not a lot of love lost on them from the American public. Painting hedge funds as the villains is a populist message at a convenient time," said Lawrence Glazer, who invests in hedge funds at Mayflower Advisors.

Some see the hedge-fund industry as a scape-goat for deeper problems facing endangered financial firms.

"What is 100 percent clear is that hedge funds did not create this problem," said Paul Roth, one of New York's most sought-after hedge-fund lawyers at Schulte, Roth & Zabel.

"This is a balance-sheet problem," he added.

By forcing hedge funds to open their books, managers who focus exclusively on short selling, fear they will soon lose all advantage. Other players could copy their trades, several prominent managers said, adding this could create more liquidity problems.