A long-running investigation into allegations of manipulative trading in the market for private stock placements by small companies is about to heat up.

The Securities and Exchange Commission is close to bringing enforcement actions against at least two hedge funds that have been active players in the $14 billion-a-year market for PIPEs, or private investments in public equity, people familiar with the inquiry say.

Within the past few months, the SEC formally notified one of the hedge funds that it is facing potential regulatory action by sending it a so-called Wells Notice. The other hedge fund has yet to receive a Wells Notice, but regulators are close to taking that next step, sources say.

The identities of the hedge funds could not be confirmed. But the looming regulatory actions would be the first taken by the SEC against any hedge fund in the nearly 2-year-old inquiry into PIPEs, financing transactions that are often used by cash-strapped companies.

The probe is focusing on allegations of stock manipulation by hedge funds, which tend to be the biggest investors in these shadowy stock sales, and allegations of wrongdoing by the Wall Street firms that round up buyers. PIPEs are popular with hedge funds because the buyers usually get to buy shares at a steep discount to the current market price.

Critics contend the ability of a hedge fund to purchase discounted stock makes the PIPEs market ripe for abuse by disreputable short-sellers, traders who place market bets that a stock will decline in price.

Some 18 months ago, the SEC, in conjunction with the NASD, began a broad inquiry into the PIPEs market. Regulators issued subpoenas and requests for documents to 20 brokerages that have arranged the majority of PIPE deals. The SEC issued subpoenas to about 10 hedge funds, several of which are big PIPE investors.

An attorney who represents several hedge funds contacted by regulators says the SEC is "looking at bringing a series of enforcement actions involving big PIPEs players." The attorney, who didn't want to be identified, says none of his hedge fund clients has received a Wells Notice from the SEC.

A regulatory source who also did not want to be identified says the "SEC is very interested in this area." The source said he "expects some more cases" in the near future.

One notable hedge fund that has drawn scrutiny from regulators over the past several months is HBK Investments, a big $7 billion Dallas-based hedge fund, sources say. The multistrategy fund is perennially one of the biggest investors in PIPEs. During the first six months of this year, HBK sank $53 million into six different transactions.

One particular PIPE deal involving HBK that regulators have looked into is a $3.4 million financing transaction for Plano, Texas outsourcing firm PFSweb ( PFSW), say people familiar with the deal. HBK was the largest investor in the 2003 financing.

Jon Mosle, HBK's general counsel, declined to comment, noting the hedge fund has a policy of not talking to the press. PFSweb CFO Thomas Madden also declined to comment.

To date, most of what is publicly known about the investigation has revolved around a 4-year-old PIPE deal for Compudyne ( CDCY), a small security services firm.

In May, the SEC and the NASD reached a $1.45 million settlement with former hedge fund manager Hilary Shane, charging her with fraud and insider trading. They charged Shane with illegally profiting from a series of short trades she made in Compudyne's stock.

As an investor in the PIPE, regulators say, Shane had advance knowledge that the private placement would price Compudyne's shares at a significant discount to the going market price. And relying on that inside information, the regulators say, she made improper short bets against the company's stock. They also allege Shane used some of the discounted shares she obtained in the PIPE to close out her short positions.

The investigation into the Compudyne transaction also led regulators to pursue a potential enforcement action against Friedman Billings Ramsey ( FBR), the investment bank that lined up hedge funds to invest in the PIPE deal. For the past six months, regulators have been involved in settlement negotiations with Friedman Billings and three former executives, including Emanuel Friedman, the firm's co-founder and former co-CEO.

Friedman resigned as CEO in April , just one day before the SEC and NASD formally notified him that he could be charged with "aiding and abetting" insider trading in the Compudyne deal.

Friedman Billings, however, isn't the only Wall Street firm to get ensnared in the PIPEs investigation.

This summer, Knight Capital ( NITE) disclosed that its Deephaven asset management group could face potential regulatory action over its trading in a series of PIPE deals from June 1999 through March 2004. Refco ( RFX), meanwhile, has set aside $5 million to cover the cost of settling allegations that some of its brokers acted improperly in arranging trades for an investor in a PIPE transaction.

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