Lending out stock to hedge funds and other wealthy investors has long been a staple business on Wall Street, generating big fees for brokerage firms.

What's not as well known is that brokers often must borrow stock, too, paying their own hefty fees to mutual funds for use of their shares.

Now, securities regulators are trying to determine what happens to the estimated hundreds of millions of dollars in fees that are paid each year by brokers to mutual funds for use of borrowed stock. The

Securities and Exchange Commission

wants to know whether the fees are being plowed back into the funds for the benefit of shareholders, or if a disproportionate amount of money is simply being pocketed by mutual fund management companies.

Stocks and bonds are borrowed and lent on Wall Street for a variety of purposes, most famously for sale in "short" strategies that profit when a stock loses value. While most lending is done by brokers, they too must have a source of shares to keep the system running smoothly. Enter mutual funds, which at any given time control most of the stock in the country.

The SEC revealed its interest in mutual fund lending fees in a little-noticed speech three weeks ago by Lori Richards, director of the SEC's Office of Compliance Inspections and Examinations.

Richards, in the speech, said her office views the fees as another gray area of "undisclosed payments" and a "possible inappropriate use of funds' money." She said the SEC intends to follow the money to determine if the "proceeds of the loan go back into the fund."

An SEC spokesman wouldn't elaborate on Richards' comments, or on the inquiry, which is in its early stages.

But a person familiar with the investigation said regulators have uncovered preliminary evidence that, at some mutual fund companies, not all of these fees have been returned to shareholders. Regulators are still tracing the money to see whether the short-changing of shareholders was intentional and just how pervasive the potential problem is.

The issue for regulators is whether mutual fund management firms are skimming some of the profits from their stock lending operation for themselves. While no one begrudges a management firm the right to collect a reasonable fee as compensation for arranging a stock loan, securities experts say the lion's share of revenue generated from these transactions is the property of the fund's shareholders.

Critics point out that management firms already earn rich fees simply from managing a portfolio, aside from any additional money they make from stock loans.

The mutual fund industry, still reeling from the fallout from the investigation into improper trading in mutual fund shares, seems a bit taken aback by the newest controversy. John Collins, a spokesman for the Investment Company Institute, the industry's main trade association, said lending out stock to brokerages is a well-established practice.

"Many funds participating in securities lending do so to earn additional income," says Collins. "The fund has to disclose it as a fundamental investment policy. Our understanding is that the proceeds go to the fund."

But most mutual funds provide few details about their stock-lending operations in fund prospectuses. Fund companies rarely tell shareholders how much revenue they generate from stock lending and how the money is disbursed.

In fact, there's so little public information about mutual fund stock-lending programs that the ICI, the mutual fund trade group, doesn't keep any official statistics on it. At most funds, stock lending is one big black-box operation.

"There is no visibility in it," says Timothy Ghriskey, chief investment officer with Solaris Asset Management and a former manager of the Dreyfus Fund. "Personally, I think the money should go back to the shareholders. These are securities that belong to the fund holders."

Ghriskey says mutual fund portfolio managers typically play no role in deciding how much stock is lent out to brokers. He says most portfolio managers are rarely consulted on the matter.

Roy Weitz, editor of FundAlarm, a popular Web site that casts a critical eye on the mutual fund industry, says he's not surprised regulators are looking into securities lending, since it's just another way for fund companies "to try and squeeze out every last dollar of revenue."

"The pattern would suggest this is exactly where you would want to look for a problem," says Weitz. "You have these vague disclosures that give a lot of power to the fund companies. There is a lot of maneuvering you can do under these disclosures."

But if done properly, stock lending also can be a portfolio manager's best friend, especially in a lean year. An ICI report on the subject notes that a successful stock-lending program "may add several basis point to a portfolio's performance."

Also, if mutual funds weren't in the stock-lending business, many say trading on Wall Street, especially in illiquid stocks, would be much harder. That's because mutual fund companies are a natural reservoir of supply for Wall Street brokerages to turn to when shares are scarce.

Wall Street firms need to have a ready supply of stock on hand to meet the demands of hedge funds, which frequently open up short positions on a particular stock by borrowing shares.

"These brokers have to have do these deals with the fund companies because they often don't have enough stock to lend to their own customers," says one hedge manager. Brokers need "access to large pools of shares in order to lend it out."