Investment banks in US face inquiry into 'hedge fund hotels'

Some of Wall Street's biggest investment banks are under investigation for operating "hedge fund hotels", providing office space to hedge funds in the hope of winning lucrative business from them.

Massachusetts authorities have demanded documents from UBS, which leases 400,000 sq ft of office space to hedge fund managers across the US, amid suspicions that investors may be short-changed.

William Galvin, the Massachusetts secretary of state, said he is examining whether hedge funds are being offered a cheap rent by the banks but making up for it by paying the banks higher trading fees.

The bill for trading fees would ultimately be picked up by the hedge funds' investors.

The investigation is at a preliminary stage, Mr Galvin said, and it is too early to say whether it may lead to enforcement action resulting from any findings of securities law violations. However, he has concerns about potential conflicts of interest. "It's really about fairness to average investors and openness in the financial services industry," he said.

UBS is one of the biggest operators of hedge fund hotels, which offer a temporary home to fast-growing funds, complete with secretarial and IT support staff. Bear Stearns is another big player, while Lehman Brothers and Goldman Sachs have much smaller operations.

In the fast-evolving world of hedge funds, there are always new managers springing up with a few star traders or a captivating new trading strategy, and the most successful can grow fast. And because hedge funds trade so much more actively than traditional institutional investors, Wall Street's big brokers are keen to build early relationships.

UBS said it had co-operated with the secretary of state's request for information, but declined to comment further. Mr Galvin did not say if he had asked for documents from any of the smaller hedge fund hotel operators.