Millennium Partners, one of the hedge funds at the center of the mutual fund trading scandal, has set aside 10% of its investors' money in preparation for a possible settlement with federal or state regulators.

Investors at the $3.2 billion hedge fund run by Israel Englander, the storied Wall Street trader and buyout specialist, learned in December that some of their money would be set aside for the firm's legal reserve, even as backers clamored for their cash. About $800 million has streamed out of two Millennium hedge funds since the firm surfaced in the mutual fund late-trading and market-timing scandal last October.

Millennium's decision to set up a legal reserve looks prudent, particularly after a former trader, Steve Markovitz, pleaded guilty in October to making illegal late trades in shares of mutual funds. The action is similar to one taken by Veras Investment Partners, a Sugar Land, Texas, hedge fund that put away up to $100 million to cover any fines and penalties regulators might impose in their investigation of its role in the mutual fund scandal.

Harry Davis, a partner with Schulte Roth & Zabel and one of Millennium's outside attorneys, didn't return repeated phone calls. Tom Daly, a Millennium spokesman, declined to comment. TheStreet.com reported Tuesday that a number of witnesses familiar with Millennium and Markovitz have appeared before a New York state special grand jury that is investigating the mutual fund industry.

While Millennium investors have been pulling out of funds, the situation would be worse if not for restrictions in their investment agreements that allow Millennium to bar larger withdrawals. Millennium's investors include Duke Management Co., which runs Duke University's $5 billion endowment; the Belzbergs, one of the richest families in Canada, and many funds of hedge funds.

According to an investor that still has "a few million" in one of Millennium's hedge funds, word of the legal reserve was one of very few communications the beleaguered Englander has offered to his backers in recent months. While the fund was once open about market-timing, a legal-if-frowned-upon strategy involving frequent trades, it clammed up around the time of the Markowitz late-trading plea, the investor said.

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