Hedge funds are hot, very hot.

American hedge funds have grown in popularity, with an estimated $1 trillion of assets, accounting for nearly 20% of the trading volume on the New York Stock Exchange. Every time you turn around, there’s a hot new hedge fund with a hot new investment manager.

For many years, hedge-fund investors were an exclusive club of wealthy individuals. But more and more of the rest of us, sometimes unknowingly, have been indirectly investing in hedge funds through pension fund investments.

One of the last vestiges of unrestricted entrepreurship, hedge funds have been flying under the regulatory radar screen for a long time. Last year, though, the Securities and Exchange Commission, fearing creeping “retailization” of hedge funds and a perceived increase in fraud, jumped into the act. The commission in December adopted much-debated rules that require many hedge-fund managers to register as “investment advisers.”

The new rules, regulators say, give them the power to track the activities of investment advisers, keep out “unfit persons” who might perpetrate fraud, ensure that advisers comply with laws, and limit the so-called “retailization” of funds. Critics, including two commissioners, say that the new rules are unnecessary, burdensome, and will not accomplish the commission’s goals.

Although the securities laws do not define hedge funds, they are basically pools of assets managed by investment professionals who typically charge a management fee and take a percentage of profits. Calling these asset pools “hedge funds” is really a misnomer. While some early funds were designed to “hedge” against market downturns, today’s hedge funds come in all shapes, sizes, and flavors, and use all kinds of investment techniques to try to maximize returns. They have attracted attention because they often use leverage and short selling, which can be risky.

Federal regulations don’t apply to hedge funds because the funds are not publicly offered, and either limit the number of investors to 99, or limit participation to those who meet certain wealth criteria. In recent years, hedge funds have made headlines, starting with the 1998 collapse of Long Term Capital Management, which nearly brought down the global financial system. And, some hedge funds triggered the recent mutual fund scandal uncovered by the New York Attorney General Eliot Spitzer, in which the hedge funds were accused of directing assets to managers in exchange for the ability to trade mutual fund shares after the market closed.

So what’s all the fuss about?

Generally, investment advisers must register with the commission if they have more than 14 clients and manage more than $30 million. Until now, the commission counted a hedge fund as one client, even if it had 400 investors. Now, if more than 14 people invest, the investment adviser must register, no longer remaining anonymous. At first take, this does not sound like such a big deal. But registration is just the beginning. Investment advisers must comply with a myriad of complicated rules. Critics claim the new rules effectively discourage small entrepreneurs – the proverbial two guys and a dog operating out of a garage – because the start-up and ongoing compliance costs can be prohibitive.

Also, many believe managers will structure funds to take advantage of the few remaining loopholes – like structuring funds with a two-year-and-one-day “lock-up” that prevents investors from bailing out absent “extraordinary” circumstances, such as the death of a portfolio manager. Managers of these hedge funds need not register.

Here in London, non-American investment advisers are grousing that the new rules go too far. Non-American hedge funds that admit too many American investors will feel the long arm of the SEC, which can reach across the Atlantic and subject advisers to certain American laws. European investment advisers are not thrilled by this prospect.

American regulators lack sympathy for those who cry hardship and assert that the benefits of requiring hedge fund advisers to register with the commission far outweigh the costs.

“Hedge funds can today have an enormous effect on our securities markets and on a wider range of investors than you might expect,” said the commission’s Associate Director of Investment Management at the International Bar Association’s conference, Robert E. Plaze. “What the new rule would do is to begin to hold them accountable.”

The rules aren’t enacted until February 2006, so if you want to invest with a fund managed by an unregistered adviser, get out your checkbook now.

Mr. Baris, a partner in the New York law firm of Kramer Levin Naftalis & Frankel LLP, is a financial services lawyer.