After the dozens of crimes involving hedge fund fraud over the last decade and the millions of dollars bilked from investors, the SEC rationalizes that somebody should step in to quell this epidemic of smooth talking swindlers. For that matter, even reputable names like the one time Bear Stearns don’t always adhere to the best practices.

Two hedge fund managers at Bear who are responsible for the implosion of two billion dollar funds swore to investors that the fund was doing fantastic. Performance reports showed no worries. Only internal emails to each other highlighted the scare and warned of the future demise of the fund. Could tighter regulation have prevented that problem? The SEC says yes.

In 2006, the SEC passed a rule that all hedge funds would have to register as investment advisors, only to have it overturned by the federal government. Dozens of high profile hedge funds wrote letters explaining why hedge fund regulation would result in more bad than good and that the SEC was overstepping the boundaries of its jurisdiction. Others argued that investors in hedge funds are highly sophisticated and they don’t need protecting. There are already rules set in place as to who may invest in a hedge fund, and as long as the investor knows there is risk involved, it is ultimately his decision.

Federalism then forced the arguments into the state’s hands, while some states pushed for tighter regulations and others like New York and Connecticut opted against it. After California called for stricter measures, it was ultimately overturned earlier this year after many prominent hedge funds expressed concerns that regulations would only push hedge funders into other states while taking their vast incomes and purchasing power with them.

One of the reasons that managers oppose greater transparency is the need for secrecy in their strategy. Since hedge funds may entertain a wide variety of strategies and combination of strategies, managers are very reluctant to let others view their moneymaker. Once a strategy is exposed, other managers may follow suit leading to the drying up of the waterhole so to speak. Particular strategies are the product of the brilliance behind the manager and other integral members of the staff and therefore do not want to be given up.

Also, since most hedge fund strategies are so complex, many investors might not understand the entirety of it anyways. Why disclose something that would only aid in confusion? Another reason is the obvious need for the non-disclosure of price. Buyers typically want to buy at the price you paid for it, not under the circumstances where you are going to make a killing off what they pay.

Size also correlates to the amount of transparency involved. Smaller, newer funds may have to disclose more information in order to attract capital and new investors. They may have to be entirely open on where investments are going and how they are allocating the cash. Larger, more established hedge funds are a different story. They may have an abundance of capital and are therefore not concerned with attracting new investors. If this is the case and the money is already locked up, they may become very secretive and start investing in riskier securities or use outlandish strategies to start reaping high returns in a short time frame.

But what is the investor’s role in all of this? Do they typically side with the openness pushed for by the SEC or the hush hush tendencies of hedge fund managers? One might think this is an obvious answer, with investors wanting to know exactly where their millions are going. But recent trends show just the opposite. Apparently, when it comes to hedge funds, trust is the key word.

Managers that have worked in the industry for years generally have a vast number of contacts and have gained the trust of many affluent individuals. I doubt that John Paulson, the man whose hedge fund has returned billions for investors, has to sit down and convince people of his accolades. If trust is directly related to experience, then established managers should have no problem recruiting investors.

Regulation or not, it is ultimately up to the investor to make the final decision. The SEC will never stop funds from collapsing, no matter how much light they shed on them. If hedge funds could promise massive returns and no losses, then everybody would invest. Reward only comes with risk. It always shocks me when investors are dismayed over an asset freeze. This is a real and distinct possibility that you knew could possibly happen going into the fund. Not that I think it’s fair or right. Keeping someone from their own money seems somewhat illogical. But still, it’s a pretty common practice. Some hedge funders just want to ride a bad wave out in the market and want to focus on strategy rather than dealing with withdraws and the liquidity crunch that would ensue. Unfortunately, a lot of the times, a redemption freeze is a precursor to the fund’s closing. These are things to think about. An investor in a hedge fund holds a certain responsibility.

Some choose to spend the money and perform a due diligence check. This is a smart idea and will raise any red flags in the manager’s past. Others choose to bypass this slightly expensive process and take faith in the manager. Whatever sleuthing they choose to participate in, the investor is always going to be exposed to risk. But the lure of the $3 trillion hedge fund industry and the very real possibility of massive returns will always ensure that there is no shortage in interest.

On the surface, it seems odd that an investor can use their position to shake up management. However, some hedge funds or high net worth investors have substantial stakes in a company, sometimes 10% or more. When these kinds of numbers come into play, hedge funds feel they have a right as to what goes on behind the scenes. Board members and company management tend to disagree. And thus, the proxy battle begins. Some recent examples will help to shed light on this often uncomfortable process.

Let’s take the most recent case involving Yahoo. Yahoo, perhaps the most notable online destination in the world, was feeling the heat from…Carl Icahn. Who the heck is Carl Icahn? A self-made billionaire and former Wall Streeter who built up a significant stake in Yahoo and felt that gave him the right to intervene on corporate matters. Corporate matters, in this case, being the potential merger with Microsoft, which Icahn felt would position Yahoo better against its biggest competitor, Google. After Yahoo CEO Jerry Yang and the board turned down a $44.6 billion bid from Microsoft saying that it “substantially undervalues” the company, Icahn waged a battle.

His goal was to replace Yang and other members of Yahoo’s board who he felt had a personal vengeance against Microsoft and weren’t looking out for the shareholders. Icahn rallied his troops and gained the support of a few prominent hedge funds, including Paulson & Co., the hedge fund ran by John Paulson who was notorious for making $3 billion from the subprime fallout.

Despite Icahn’s influence and his posse, a Microsoft buyout never came to fruition. However, Icahn kept his nickname as the “corporate raider,” which he got back in 1985 after a hostile takeover of TWA and not much to show for it after.

Another similar case involved women’s plus size clothing manufacturer Charming Shoppes Inc. Two hedge funds, Crescendo Partners and Myca Partners, built up a 7.9% stake in the company, or about 9 million shares. When stocks reached an all-time low and performance was lagging, the hedge funds felt it was time to take charge and proceeded to nominate three hedge funders to the Board.

What followed was a nasty proxy battle in which shareholders were bombarded with emails, where Charming Shoppes would accuse the hedge funds of acting on their own greed, and where the hedge funds would accuse the company of having a flawed business structure. After months of nasty words, the two finally reached an agreement, where the hedge funds would receive two seats on the Board.

So why then, instead of cashing out and focusing on other investments, do hedge funds wish to linger and cause a stir? Taken from a recent statement to shareholders, hedge funds TCI and 3G Capital Partners may have the answer:

“Michael Ward, the Chairman and CEO of CSX, wondered why we haven’t just taken our profits and sold our shares, much as the board and management of CSX have done over the past two years. If we believed that CSX already had achieved its full operating potential, that’s exactly what we would do. However, in our view, CSX has only just begun to improve…”

TCI and 3G are also involved in a fierce proxy battle with railroad operator CSX, claiming that the current Board has little or no railroad experience. They are seeking their own slate of nominees for the Board, having acquired an almost 9% share of the company.

Hedge Funds are not well known for sitting passively while patiently awaiting returns. However, if recent cases have set the precedent, more and more powerful hedge funds and aggressive investors will be pushing for changes in management via Board rearrangement. It is up to the shareholder to take an active role in deciphering who is looking out for the company, and who is seeking personal gain.

To some, Obama represents a long awaited revolution; a beacon of hope in the wake of a lagging economy and five years of a questionable war with no clear exit plan in sight. To others, he is merely an inexperienced congressman; a fish out of water whose rhetoric is far more appealing than his potential. McCain: A celebrated POW who endured years of hardship in Vietnam and who, more than anyone, understands the need to get us out of Iraq. To others, he is George W. Bush’s puppet; an obedient replica of our current leader with little variance to offer once he gets into office.

War debate aside, there is an extended agenda of issues on everyone’s mind this year. 47% of Americans cite tax issues as an area of great importance in the 2008 Presidential elections. So where do the two men stand? It has to be more complex than the cliché of the Republican standing behind the white collar worker, handing out tax breaks to corporate executives with the same enthusiasm they use to reject universal healthcare, doesn’t it? In fact, if the wealthy were so apt to align themselves with McCain, how did Obama garner such great support from the hedge fund industry?

Obama and his tirade of tax reform initiatives will no doubt shake up the current plan. From his “Universal Mortgage” credit to his “American Opportunity” initiative, Obama is certainly looking to put back into American’s pockets. But at what cost? While he seems eager to give back to the middle class, he won’t think twice about raising the capital gains tax to 25%. What does this mean?

Capital gains taxes are paid when an individual or corporation realizes a net profit on their assets, generally when an investment is sold at a higher price than what it was purchased for. For hedge fund managers, the capital gains tax is a huge factor, since millions of dollars of securities are traded within that fund.

Let’s say a fund manager takes home $3 million deriving from his 20% standard performance fee that he charges his clients. He will classify that as a capital gain, thus only having to pay $450,000, or 15%. If Obama’s proposal goes through, the fund manager now pays $750,000, or 25% of his income. While this may raise some complaints, supporters say this is still a tax break. If that $3 million were considered a salary as opposed to a capital gain, it would be charged the normal tax rate of 35%, or a little over $1 million.

With much less simpler (and for that matter, less confusing) initiatives, McCain’s focus is less on the middle class and more on the extreme ends of the spectrum. Both wealthy individuals and low-income families will get tax breaks, though the resulting after-tax income differences are no-doubt more prevalent on those who make substantially higher salaries. Rationalizing that low taxes on dividends and capital gains promote savings and financial planning, McCain will keep the current capital gains tax where it is, while fighting “anti-growth” measures brought on my dems. In this sense, he does mirror Bush. In fact, the only time he ever deviated away from his beliefs on the tax front was in 2001, fresh off a bitter primary defeat, where he voted against the Bush tax-cut initiatives. Lucky for the republicans, it didn’t take long before he was right back on track.

What’s interesting was the hedge fund involvement in the primaries that was surprisingly pro-democratic. Through extensive Wall Street contacts, Hillary Clinton amassed millions from prominent hedge funds. However, I think their support slowly faded after her intentions were announced to raise the capital gains tax to 35%, even if Marc Lasry does feign disgust at the “ridiculous” salaries made by hedge fund managers. Not far behind Clinton, Obama brought in a little over $1 million from hedge funds in 2007. McCain barely broke $400,000. One would think they would align themselves with the guy who is going to let them keep more of their income. Some hedge funds are saying they’re giving more to Democrats because of their impatience with Bush’s progress in Iraq and because they see a very real opportunity for them to win control of Congress for the first time in 12 years.

So maybe it is more than the number of zeros in a hedge fund manager’s paycheck. Regardless of the issue, importance is assigned to them by each individual. Maybe the tax issue is the highest for some. Maybe it’s gay marriage or whether or not steroid use in baseball should be persecuted. Either way, this election is unlike any that have come before, and the issue of capital gains is merely one issue that the voter should individually assess.