Sept. 18 (Bloomberg) -- The U.S. Securities and Exchange Commission is examining hedge funds for signs of insider trading, demanding information about relationships between managers, employees, family members and public companies.

SEC officials told hedge funds to list clients and workers who serve as officers or directors of publicly traded companies, along with the names of any relatives who hold such posts, according to a 27-page letter to industry executives obtained by Bloomberg News. The SEC confirmed its authenticity.

``The SEC is really drilling down, trying to get very specific information that might give them leads on insider trading,'' said Nora Jordan, a lawyer at New York-based Davis Polk & Wardwell who represents hedge funds in SEC examinations. ``Some of the information that they have asked for has never been asked for before, and many clients are not keeping it.''

Unusually high trading in shares and options before takeover announcements by companies including TXU Corp. and First Data Corp. has intensified scrutiny of how market-moving information spreads among hedge funds, investment banks and leveraged buyout firms. The SEC's office of compliance and inspections referred 223 cases of potential securities violations to the agency's enforcement division in the latest fiscal year.

Since April 2006, the SEC has filed insider trading-related lawsuits against more than a dozen investment bankers, analysts and executives whose jobs require them to safeguard clients' secrets. That's more than during all of the 1990s.

Fund Inspections

The SEC's New York office started using the new examination letter, which is more extensive than previous versions, after lawmakers including U.S. Senator Charles Grassley, an Iowa Republican, questioned the agency's record in detecting illegal trading.

In addition to information about officers and directors, the SEC wants the identities of any relatives who work at brokerage firms, as well as a detailed description of any ``deal'' that a fund manager ``was asked to consider'' and turned down ``because the proposal was deemed inadvisable, inappropriate, unethical, or possibly illegal.'' The letter asks for e-mails and contact information for all involved.

The SEC's questions focus on ``risks for potential insider trading,'' said Mark Schonfeld, who oversees the agency's New York office. ``Investment advisers are required to have controls in place to prevent the misuse of non-public information, and to enforce those controls.''

He declined to say which funds received the letter.

Informants Wanted

The details the SEC is seeking about suspect deals that hedge-fund managers rejected ``implies that what they want managers to do is to be informers whenever they see impropriety,'' said David Nelson, chief executive officer of Greenwich, Connecticut-based hedge fund DC Nelson Asset Management LLC, a registered adviser overseeing about $27 million.

``I'm not sure that's what our role should be,'' Nelson said. ``If you don't inform on somebody, are you liable?''

Hedge funds are mostly private pools of capital whose managers participate substantially in the profits from their speculation on whether the price of assets will rise or fall. They accept investments from wealthy individuals and institutions such as pension funds.

The SEC can inspect hedge funds, and demand detailed information about their investments and clients, when the manager is registered with the agency as an investment adviser.

`Stunning'

About 1,980 hedge-fund advisers have voluntarily signed up, a 21 percent drop from June 2006 when the U.S. Court of Appeals in Washington rejected the regulator's attempts to require registration.

The SEC's new questions probably won't prompt hedge funds to withdraw from SEC oversight, because pension funds prefer to invest with registered firms, said Jay Gould, a former SEC staff attorney now at Pillsbury Winthrop Shaw and Pittman LLP in San Francisco.

Phillip Goldstein, the money manager who successfully sued the SEC to block the adviser-registration rule, said the range of questions in the agency's latest letter is ``stunning.''

``Registration is even worse than I thought,'' said Goldstein, founder and principal of Saddle Brook, New Jersey- based Bulldog Investors.

Hedge-fund managers receive SEC questionnaires tailored to their risk profiles, said Thomas Biolsi, an associate director for examinations in the agency's New York office. The SEC conducted about 2,400 reviews of investment advisers and brokers during the fiscal year ended September 2006.

Heavy Betting

``We know hedge funds are trading very heavily,'' said Harvey Goldschmid, who served as an SEC commissioner until 2005. ``When you want to find out whether there is misuse of information and the magnitude of the misuse, you ask these kinds of questions.''

TXU Chief Executive Officer John Wilder met in November with officials from buyout firms Kohlberg Kravis Roberts & Co. and TPG Inc. to discuss a possible takeover, according to a filing with the SEC. A day later, options of the Dallas-based power company surged. Regulators have sued a former Credit Suisse Group banker, his alleged conspirator in Pakistan and others in the TXU case.

The credit-default swaps of First Data bonds rose in December, days after KKR executives asked a company director whether the credit-card payment processor in Greenwood Village, Colorado, would be interested in discussing a buyout. The meeting was later disclosed in the company's proxy statement.

Wall Street Leaks

In March, the SEC accused hedge-fund managers and former employees at Morgan Stanley, UBS AG and Bear Stearns Cos. of participating in a network that leaked details about corporate takeovers.

A month earlier, the SEC asked at least 10 Wall Street firms to hand over stock-trading records for the last two weeks of September 2006, seeking to determine whether they leaked details about stock trades to favored clients such as hedge funds.

Both probes are ongoing.

To contact the reporters on this story: Jesse Westbrook in Washington at jwestbrook1@bloomberg.net; Jenny Strasburg in New York at jstrasburg@bloomberg.net.

Last Updated: September 18, 2007 16:39 EDT