Cornell Capital Partners, a hedge fund that specializes in finance for ailing penny-stock companies, is being investigated by securities regulators for its trading activity in shares of nine companies.

The Jersey City, N.J.-based hedge fund, which has more than $200 million in assets, disclosed the investigation in its most recent audited financial statement, a copy of which was obtained by TheStreet.com. Copies of the hedge fund's 2004 financial statement were mailed to Cornell investors in late August.

The Securities and Exchange Commission investigation of Cornell stems from a broad-based regulatory inquiry into allegations of manipulative trading in the $17 billion-a-year market for PIPEs, the Wall Street acronym for private investment in public equity.

For the past two years, securities regulators have been looking into the activities of hedge funds that invest in PIPEs and the brokerages that help arrange these private stock sales for companies in desperate need of cash. TheStreet.com previously reported that at least three other hedge funds -- HBK Investments, Gryphon Partners and Alexandra Investment Management -- are being investigated by regulators.

PIPEs are a popular financing route for tiny, cash-strapped companies, which raise money by selling discounted shares to investors in a privately negotiated transaction. But the ability of a big trader to purchase thousands of shares of discounted stock also makes the PIPEs market ripe for abuse by unethical short-sellers -- traders who bet a stock will decline in price.

Mark Angelo, the founder and president of Cornell, says regulators haven't told him they've found any wrongdoing involving the hedge fund. Angelo says Cornell is probably being investigated because it's a major PIPEs player and is involved in so many deals each year.

"I think they're looking at all people in the PIPEs space,"' says Angelo. "Most of our investors view it as non-issue."

Since its inception in 2001, Cornell has provided financing to more than 120 speculative, mostly money-losing companies, many of which trade shares on the over-the-counter Bulletin Board. In the third quarter of this year, Cornell was the ninth most active PIPEs investor, sinking $38 million into 10 different deals, according to PlacementTracker, a private placement research firm.

The PIPEs market has been a profitable niche for Cornell. In 2004, it realized a $20 million net gain on investments, according to the financial statement. It took in another $3.4 million in investment income.

The investigation of Cornell began in July 2004 with the SEC requesting information about its "funding of and trading" in shares of Bio-One, a defunct nutritional supplement company that had operated out of Winter Springs, Fla. Cornell had been the primary investor in two PIPEs deals that raised $25 million for Bio-One and enabled the company to make two small acquisitions.

By this summer, the SEC investigation had expanded to include eight other companies Cornell had invested in. The audit doesn't disclose the names of the other companies. However, the 13-page report notes that Cornell received a subpoena from the SEC on July 18, 2005, seeking documents "related to the funding of and trading in the common stock of Bio-One and eight other portfolio companies in which the partnership is invested."

Two months ago, the SEC reached a settlement with Bio-One over allegations that its financial statements failed to disclose an August 2004 default on a $15 million promissory note to a company it had acquired earlier that year.

Angelo says the SEC began investigating Cornell because it had provided financing to Bio-One. But he says Bio-One company kept the default on the promissory note hidden from Cornell, too.

"We have no idea why we were named in this, other than that we are an investor," says Angelo. "I have no idea why we were named."

Angelo declined to discuss the eight other companies the SEC has asked for information about. An SEC spokesman declined to comment.

One of the allegations regulators are looking at in the PIPEs probe is that some hedge funds routinely shorted a stock once they learned a PIPEs deal was in the works. Regulators contend that such premature short trades are illegal, because knowledge of such deals is confidential, nonpublic information.

It's not uncommon for stocks of companies doing PIPEs deals to drop in price after it becomes public that the company has sold thousands of shares at a discount.

Hedge funds, however, aren't the only target of the investigation, which is being coordinated with the National Association of Securities Dealers and in some instances, the Department of Justice. Investigators also have targeted brokerage firms that serve as placement agents for PIPEs deals by lining up investors.

To date, the broad-based inquiry has led to the criminal conviction of a former SG Cowen managing director on insider trading charges, and a $1.45 million civil settlement with a former First New York Securities hedge fund manager. Emanuel Friedman, former co-CEO of Friedman Billings Ramsey ( FBR), also faces potential civil charges, as does the investment firm he co-founded.

Other Wall Street firms that face potential regulatory action arising from the probe include Knight Trading ( NITE) and Refco ( RFXCQ), the scandal-tarred commodity and derivatives brokerage.

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