Whatever the Commodity Futures Trading Commission finds out about disputed asset pricing at the Clinton Group of hedge funds, the most surprising thing about the investigation is that it happened at all.

The federal agency that was once poised to become the most active regulator of the diffuse and opaque hedge fund industry spent the last three years backing away from its oversight role, to the point where some former CFTC officials worry that derivatives trading, a critical sector of U.S. financial markets, is dangerously unsupervised.

Under chairman James Newsome, a former lobbyist for the Mississippi cattle industry, the CFTC has reduced the criteria that once forced many hedge funds to submit annual reports as registered commodity pool operators and commodity trading advisers. In August, the agency passed a set of rules relaxing reporting requirements for hedge funds, many of which were overseen by the agency because they trade futures contracts.

The nearest thing the hedge fund industry has to a lobbying group is the Managed Futures Association. Since 2000, the MFA has stepped up its lobbying efforts with regulators, asking the

Securities and Exchange Commission

to let hedge funds advertise and pressing for minimal disclosure and registration requirements for fund managers.

While the Clinton Group is not a member of the Managed Funds Association, founder George Hall was a featured speaker at an MFA conference in June. Richard Clarida, Clinton's chief economic strategist, is scheduled to address another MFA conference in February.

Clinton's problems came to light in October, when senior trader Anthony Barkan resigned and issued a public statement about his concerns over possible mispricing in asset-backed securities portfolios in the firm's $4 billion hedge fund business. The firm quickly hired PricewaterhouseCoopers to check its valuations, but with hedge funds under the microscope, Clinton was soon visited by both the SEC and CFTC.

It was an unusual move for the latter.

"This is a very strange time for the CFTC to be investigating anybody," says one person who knows the agency well. The agency, this person says, has been stepping away from its regulatory duties since 2000 and gets involved in big investigations only when it can't avoid them.

"The CFTC took a deregulatory course, even though the SEC was moving in the other direction. They probably gave up regulatory jurisdiction over half the funds they regulated."

A CFTC spokesman says the agency doesn't comment on whether it is investigating particular firms, but says it is "very active with enforcement and investor protection." The agency's Web site lists 109 enforcement actions taken this year, many against foreign currency traders and energy derivatives traders.

But hedge funds are less of a priority. While the SEC now appears to be leaning in the direction of increased regulation for hedge funds, the MFA has succeeded in easing CFTC oversight. Part of the reason is the extensive contacts between the MFA and the agency it lobbies. MFA president Jack Gaine has a history of working well with Newsome, and last year the CFTC hired former MFA general counsel Patrick McCarty as its own general counsel.

While he lauds the deregulatory direction of the CFTC over the last several years, Gaine points out that the agency's antifraud provisions remain unchanged, and that funds could face criminal and civil penalties for misrepresenting or misvaluing their assets or performance.

Gaine has high praise for Newsome. "I share his views, particularly on market development," Gaine says. "I think he's the best, or one of the best, chairmen they've had over there."

"In this situation, you basically have the CFTC very much influenced by a lot of the industry groups it represents," says Michael Greenberger, a law professor at the University of Maryland and the former director of trading and markets at the CFTC.

"Chairman Newsome is as deregulatory as any chairman the CFTC has had," says one agency veteran. "Once McCarty was brought in as general counsel, well, it certainly sent a signal."

The CFTC also delegates much of its investigative work to the National Futures Association, a self-regulatory organization that handles initial complaints and concerns about futures traders, similar to the way the NASD sometimes works in conjunction with the SEC.

But the CFTC does spend money and put resources into its own investigations; it sent $22.8 million of its tiny $82.8 million fiscal 2003 budget to its enforcement division, which is well regarded, though much smaller than the SEC's operation.

Randall Dodd, a former CFTC economist who now runs the Derivatives Study Center, a Washington think tank, says the agency has long been underfunded and understaffed, long before its recent deregulatory bent.

"You can't send David in against Goliath every day and expect him to win," he says. "The derivatives industry has grown so much faster than banking or equities or insurance, and regulation has not kept pace."

Dodd and Greenberger both say the agency's value was most apparent in 1998, when the CFTC was the only federal body that had any information on Long Term Capital Management, a heavily leveraged hedge fund that was on the verge of blowing up while holding derivatives with a notional value of $1.25 trillion.

After the Treasury Department, the

Federal Reserve Board

, and the Federal Reserve Bank of New York convened to organize major investment banks in a hasty and expensive buyout of the bankrupt fund, the CFTC was the agency that called out for regulation of over-the-counter derivatives activity, says Greenberger.

"They recommended at the time that there be a rigorous reporting of hedge fund activities to the federal government, but the question about how it would be done was left open," he says. "But after

then chairman Brooksley Born retired in 1999, each new chair became more devoted to moving from regulation to deregulation."

At the same time, he says, the Securities and Exchange Commission was starting to look more seriously at regulating hedge funds.

"Even Harvey Pitt saw that hedge funds were having an impact on the economy," Greenberger says. "Now the SEC is in the driver's seat, but it doesn't have the most direct regulatory tools that the CFTC had. And they've given up every meaningful regulatory peg they had."

Greenberger says the agency's enforcement actions now are directed at small-time operators, "and there are a lot of them and they can be very bad," but that it won't go after pillars of the futures industry.

"Look at the MFA -- they can't say enough good things about how good a regulatory agency the CFTC is, and that is because it is basically a toothless regulator. Anything they're doing with Clinton, they've basically been dragged into."