Paul Roth, a New York lawyer with a big list of hedge fund clients, recently opined on why Washington will never get the fast-money crowd.

Discussing the ability of regulators to understand how a portfolio of illiquid securities like mortgage bonds is priced, Roth summed up the disconnect between hedge funds and the Beltway.

"It's like someone who's trained as a physicist trying to explain his work to a fifth-grader in elementary school math," Roth said.

The remark goes to the heart of a now-raging debate about hedge fund regulation, one that has riven the

Securities and Exchange Commission's

five-member commission and prompted warnings from Alan Greenspan himself. Does the industry's own arrogance make tighter regulatory control a necessity? Or are hedge funds too complicated for a small group of underpaid government lawyers to rein in?

A new proposal from SEC Chairman William Donaldson has the industry on the defensive. Donaldson wants more money and reportedly more agents to police the murky world of private investment pools. He has made hedge fund regulation a priority of his administration, arguing the funds played too big a role in scandals like the one currently afflicting mutual funds to continue ignoring.

The plan hasn't passed yet, and the five-member commission is divided along party lines over whether regulating the estimated 6,800 hedge funds that do business in the U.S. is wise. The agency is already stretched thin in its fight against mutual fund abuses.

Hedge funds have been in and out of the political spotlight since the 1998 collapse of Long-Term Capital Management. Indications from the SEC, which last fall published an extensive report on hedge funds that concluded their advisers should be registered, suggest the debate is coming to a head, although it is not clear who will win.

The industry's position is that self-regulation is the only route to stability. According to Roth, the last 20 years in the managed futures industry was a triumph of self-regulation that easily can translate to all hedge funds. Because he was addressing a conference sponsored by the Managed Funds Association, a leading lobbying group for the hedge fund industry, his comments were well-received. But they're being echoed in Washington, too.

In a Senate Banking Committee hearing last week, Greenspan signaled his opposition to an SEC plan to formally register hedge fund advisers, which would be the most intense regulatory scrutiny many of these managers have ever encountered.

"I grant you that registration is not a problem in and of itself," Greenspan said. "The question is what is the purpose of that, unless you're going to go further."

The Fed chief added that as long as hedge funds remained the province of wealthy and institutional investors, additional oversight would not be needed.

Nevertheless, the SEC budget grew 12.5% this year, and Donaldson has said he'd like to see some of that money used to hire another 106 SEC employees, some of whom would register and inspect hedge funds. The new budget calls for $18.7 million to go to expanding the SEC's staff.

Jack Gaine, president of the Managed Futures Association, which sponsored the conference at which Roth made his comments, said the SEC's concerns over "retailization" -- the spread of hedge funds to low- and moderate-income investors -- were unwarranted. Hedge funds, which usually require a minimum investment of $1 million and have strict rules about who can buy them, can take care of their own business without government help, he said.

"We don't want mom and pop as investors," he said. "We want the sophisticated investor in a private transaction that has been worked out within the existing legal framework."

Gaine also dismissed the idea that the SEC could have learned about widespread abuses in the mutual fund industry if it had been able to inspect Canary Capital Partners, the hedge fund at the center of the late-trading/market-timing scandal. In any event, Gaine said, memories of that debacle are fading.

"Last year, you would have said there was a 90-10 chance that there was going to be regulation of hedge fund managers," he said. "I would say the balance has shifted."

Though no SEC commissioners would speak for the record, the five commissioners remain divided, despite Donaldson's November assertion that the mutual fund trading scandal demonstrated "how the activities of hedge funds can adversely impact ordinary investors."

Commissioners Cynthia Glassman and Paul Atkins -- both Republican appointees -- have consistently opposed regulation of hedge funds. Counterparts Roel Campos and Harvey Goldschmid support the staff report recommendations.

"Too much money is now being managed in the shadows," Goldschmid said in a December speech to the Investment Company Institute, the leading trade association for the $7 trillion mutual fund industry.

Hedge fund observers disagree. The increased flow of money from large institutions over the last three years forced new standards of transparency and openness on managers who needed to satisfy their new investors' greater appetite for disclosure.

Better to let smart investors set the standards for their money managers, said Adam Cooper, president of the MFA and a partner in the $9.5 billion Citadel Investment Group.

"Embrace the due diligence of your investors," he advised the assembled fund managers. "Those are the best means to ensure that the integrity of your manager is sound."

Joel Press, senior partner in Ernst & Young's global hedge fund unit, said recent regulatory actions indicate growing sentiment for regulation. He said the SEC's December settlement with hedge fund manager Marque Millennium Group over its supervisory practices is a hint of things to come, although adoption of voluntary compliance procedures could limit them.

Some regulation is already in the works. Revisions to the Investment Advisors Act of 1940 -- the major piece of legislation affecting hedge fund managers -- will require registered investment advisers to have compliance procedures and compliance officers by October of this year.

SEC Commissioner Glassman's comments in a speech she gave this week in London provided further fodder for the skeptics, who see a divided SEC trying to do more than it can manage in an area it doesn't fully understand.

"Since hedge funds are vehicles for high net worth individuals and institutions, hedge fund investors presumably have the wherewithal to conduct appropriate due diligence," she said in a speech given in London. "I wouldn't want to dilute and divert the limited resources we have to devote to the inspection of mutual funds, that are the primary investment vehicle for mom and pop investors.

"And I wouldn't want to mislead investors into thinking that the SEC exams of hedge funds give them the Good Housekeeping seal of approval. So stay tuned on this one," Glassman said.