Yet another scam on Wall Street has been enriching professional investors at the expense of the small guy. It hasn't happened here yet, but is it a symptom of an alarming trend?

Never underestimate the vigour, the ingenuity and the sheer shameless, rhino-skinned doggedness with which some professionals in financial markets go about fleecing the moms and pops. The general rule is, wherever there's gravy, there's a banker or broker skimming away more than his or her fair share.

Eliot Spitzer, the scalp-hungry New York attorney general who gave Wall Street a spanking last year over biased share analysis, has just uncovered a fresh scam. This time the victims appear to be ordinary investors in so-called mutual funds (the same investment category as unit trusts in Britain). Mutual funds are the main route through which 95 million Americans invest in the share market. Until now the mutual funds have enjoyed a relatively clean image.

But Spitzer has unearthed evidence of disgraceful double standards in the mutual funds industry, with professional investors given favourable treatment at the expense of small investors. Yet again, it seems Wall Street is swindling Main Street.

The scam worked by exploiting the system by which mutual funds are priced. Ordinary punters have to put in their buy or sell orders by a deadline, usually 4pm, at which point a price is set to match supply and demand. Spitzer found that some favoured professionals were given until 6.30pm to place their orders.

In other words, they could take advantage of changes in investor sentiment in that crucial couple of hours - due to events such as terrorist attacks, say, or diplomatic breakthroughs - to make certain money. Spitzer likens the practice to "betting today on yesterday's horse races". When he announced his initial findings he pointed the finger at four big US institutions, including Bank of America and Bank One. His investigation is continuing amid what he calls "evidence of widespread illegal trading schemes that potentially cost mutual fund shareholders billions of dollars annually".

The Financial Services Authority thinks it "highly unlikely" that something similar could happen here.

The alleged favoured client is a hedge fund, which speaks volumes about the alarming way power on Wall Street and in the City of London is shifting. Investment banks love hedge funds. Winning a hedge fund as a new client is considered twice as good as winning any of the conventional funds, which are nowadays referred to, slightly sniffily, as "long only". While "long only" funds do boring stuff such as buy shares and hold them for the long term, hedge funds can "go short" - borrow stock and sell it in the hope of buying it back at a lower price. They also take bets, lots, on all kinds of financial outcomes, generating vastly bigger fees for the banks.

Sometimes just a couple of rocket scientists and a secretary behind a brass plaque in Mayfair or Connecticut, hedge funds contract out all kinds of tasks to the banks. The business, known collectively as prime brokerage, is highly lucrative. I suspect this love affair explains the sudden acceptability of hedge funds. Three years ago they were fringe players, eschewed by most mainstream investors. Now, according to a survey from J P Morgan Fleming, 22 per cent of pension funds across Europe invest in hedge funds and a further 37 per cent are considering doing so.

In the UK, the staff pension funds of blue chips such as BAT, ICI, Prudential, Unilever, Shell and Sainsbury, and of major local authorities such as Shropshire, West Midlands and West Yorkshire, have either invested or are thinking of taking the plunge.

The banks have lovingly burnished the reputation of hedge funds as a suitable vehicle for employees' retirement nest eggs. But there are two reasons why I suspect it will end in tears. One is scale. The other is "the casino's take".

First, scale. The hedge fund stars almost all have one thing in common. They look after relatively small sums of money. They cannot bet large amounts without the price moving against them. And the arrival of the big pension-fund beasts into this corner of the investment jungle inevitably means the sums will rocket and returns will dwindle. Second, the casino's take. Hedge fund investment is a zero-sum game. For every winner, there is an equal loser. And the egregiously high fees charged by hedge fund managers make it even worse.

Contrast that with the normal types of asset bought by pension funds: shares, bonds and real estate. Over the very long term, each produces a real rate of return because economies in general grow, as do companies. In other words, investors in these conventional asset classes have the wind at their backs.

Hedge fund investors have no such natural advantage. Pension fund trustees tempted to have a punt on a hedge fund should stop their ears to the siren voices coming from the City.

Patrick Hosking is deputy City editor of the London Evening Standard

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