Hedge fund investors worry about new names in probe

By Svea Herbst-Bayliss

BOSTON (Reuters) - Just when things were starting to look up for hedge funds after a rough 2008, a mushrooming insider trading scandal could prompt investors to start pulling money out again.

The trading scheme uncovered at prominent hedge fund firm Galleon Group last month was widened on Thursday to include a number of smaller, less known firms. But it also appears to touch a prominent firm. The government's cooperation agreement with Choo Beng Lee, a former hedge fund trader turned government informant, suggests he engaged in insider trading while working at hedge fund firm SAC Capital, one of the industry's biggest and best-known.

For many hedge fund investors, the biggest fear is that a large, well-known hedge fund might also be involved, several investors and industry lawyer said.

"This could be spreading like a virus," said Michael Hennessy, managing director at Morgan Creek Capital Management, which invests $9 billion in hedge funds.

The allegations of an old-fashioned insider trading scheme, coming less than 12 months after Bernard Madoff's monumental, $65 billion Ponzi scheme was unearthed, could unnerve many investors.

"This is yet another shockwave that could serve to undermine investor confidence," said Brenda Sharton, a partner at law firm Goodwin Procter.

Pension funds, endowments and the rich, who put billions into loosely regulated and often secretive hedge funds, might be shaken most, however, because this is the first time hedge funds have been involved in such a case, lawyers said.

"Right now no one wants the career risk of being invested in a fund that might be linked to this," said Morgan Creek's Hennessy, adding that many investors are now debating how to react to the growing scandal.