Hedge funds 'testing the limits', warns FSA

The Financial Services Authority has warned the hedge fund industry that it is "testing the boundaries of acceptable practice", claiming that it will continue to keep a close eye on the sector to prevent any future market abuse.

Speaking at the Fordham Law School in New York, the FSA's director of Enforcement, Margaret Cole, said the regulator was particularly concerned that the questionable practice of a few hedge funds may be encouraging market abuse on a wider scale.

"Of particular interest to us in Enforcement is the regulator's belief that some hedge funds may be testing the boundaries of acceptable practice with respect to insider trading and market manipulation," he said.

"In addition, given their payment of significant commissions and close relations with counter-parties, they may be creating incentives for others to commit market abuse. Characteristically, our main response has been on the surveillance side and we have recently devised metrics to measure the incidence of unusual price movements in order to see if this belief is correct."

Her comments came just hours after the Bank of England's deputy governor, Sir John Gieve, warned that he believed hedge funds would be at the centre of the next crisis in financial markets. He said he had been concerned that many funds had begun taking aggressive risks again over the past few weeks, after a more conservative patch of investing over the summer. Ms Cole also conceded that the US authorities had been much more successful at prosecuting the perpetrators of major corporate frauds in recent years, praising the work of Eliot Spitzer, New York's attorney general, as well as the Department of Justice and the Securities and Exchange Commission.

"While some notable victories have been achieved in the UK - for example, the City Slickers prosecution by the DTI and convictions arising from the Guinness trials - overall, successful prosecutions of so-called 'white-collar criminals' have been sparse," she added.

Ms Cole blamed the UK's lack of success on the fact there was "greater public support" for such convictions in the US, claiming US juries had a greater willingness to convict. She added the British judiciary's dislike of so-called "plea bargaining" or "Queen's evidence" - providing immunity for those willing to help secure a conviction - has added to the difficulty. This is common practice in the US.