The Financial Services Authority has hit out at hedge fund managers over their "complacent attitude" towards setting up internal controls to prevent market abuse.
The criticisms, which followed a series of visits by the watchdog to several London firms as part of its ongoing inquiry into market abuse, will come as a blow to the $1.7 trillion industry as it seeks to preempt regulatory clampdowns by governments on both side of the Atlantic.
"Some [hedge fund managers] had a high level of awareness and appropriate controls in place, whilst others were less aware, had fewer controls and demonstrated a complacent attitude to the risks. We are disappointed by some of what we saw," the watchdog said.
"We will be following up with the firms visited and are launching a programme of visits to a wider cross section of managers over the coming months to assess formally their market abuse systems and controls."
The industry has tried to head off a regulatory clampdown by governments increasingly concerned with their influence by coming up with a voluntary code of practice. European and American regulators have raised concerns about the threat to economic stability amid high-profile blow ups of funds caught out by the summer credit crunch.
Andrew Baker, deputy chief executive of hedge fund lobby group Aima, said the "FSA's focus on market abuse and insider dealing, and the development of themed visits, is important to the hedge fund industry and welcomed by Aima." The organisation was "actively working to bring clarity to the issue."
Sir Andrew Large, the former deputy-governor of the Bank of England, published the findings of the Hedge Fund Working Group this month in which he called for the institution of a "comply or explain" regime governing transparency.
Judging by its comments, the FSA is unconvinced by the effort. "We have wider concerns about the number of leaks across the marketplace about potentially price-sensitive events. [Managers] must have in place policies to ensure that their staff are aware of the need to maintain the confidentiality of such information," it said. "We will take action in situations where we identify the deliberate leakage of information or the dissemination of rumours."
The warning came on the same day that one of the most high-profile hedge funds to have run into trouble recently was able to claim a small victory in its recovery effort. Absolute Capital Management, the AIM-listed hedge fund that lost most of its value last month after its co-founder Florian Homm quit unexpectedly, won a key investor vote.
The Mallorca-based firm was forced to hold a shareholder vote at a Grand Cayman hotel at the weekend after a group of rebel shareholders objected to the terms of a proposed overhaul of four of the firm's eight funds, which were revealed after Mr Homm's departure to be encumbered by large illiquid positions.
The rebel investors, represented by Simmons & Simmons, had threatened to block plans to two of the funds. Some last minute amendments by AbCap won investors over.