“In the latest sign of the fallout sweeping through the mutual-fund industry amid government investigations of improper trading, Alliance Capital Management Holding LP suspended two employees because of “conflicts of interest” that benefited Alliance’s hedge-fund operations at the expense of shareholders in Alliance mutual funds overseen by the same portfolio manager,” writes Susan Pulliam in today’s Wall Street Journal.

“Gerald Malone, a veteran technology-stock investor who runs the $3.2 billion AllianceBernstein Technology Fund as well as two Alliance hedge funds, and Charles Schaffran, a marketing executive who sold Alliance hedge funds to investors, were suspended. The moves were based on the preliminary results of an internal inquiry, which found that certain investors were allowed to make rapid trades in a mutual fund managed by Mr. Malone in exchange for making large investments in Alliance hedge funds also run by Mr. Malone, people familiar with the situation say.”

“The Alliance moves underscore potential conflicts long raised by critics of a trend in the mutual-fund industry for mutual-fund managers to also oversee hedge-fund portfolios.”

“Neither Mr. Malone, who joined Alliance in 1992 as a technology analyst, nor Mr. Schaffran, could be reached to comment.”

“Hedge funds, investment pools for the wealthy that are much more loosely regulated than mutual funds and are usually more profitable for successful managers, have gained popularity because they often can turn profits when stocks decline. But critics say that managers overseeing both hedge funds and mutual funds can face potential conflicts of interest if the managers have to make investment choices between the two different types of vehicles.”

“Rapid-fire trading isn’t generally considered illegal unless that activity is allowed by mutual-fund officials when it is banned by a fund’s prospectus language. Like most mutual funds, the AllianceBernstein Technology Fund overseen by Mr. Malone has language in its prospectus that discourages short-term trading. The prospectus says the fund reserves ‘the right to restrict purchase of shares (including through exchanges) when there appears to be evidence of a pattern of frequent purchases and sales made in response to short-term considerations.’ “

“Mr. Schaffran is alleged to have helped a broker at a Las Vegas firm called Security Brokerage Inc. gain the ability to make short-term trades in shares of Mr. Malone’s mutual fund in exchange for investments into Mr. Malone’s hedge funds, according to people familiar with the situation. The broker, Daniel Calugar, couldn’t be reached to comment.”

“The suspensions by Alliance were the first by a fund company not among the four cited by New York Attorney General Eliot Spitzer, who, in a complaint filed Sept. 3, alleged trading abuses by some fund companies. None of those fund companies — Bank of America Corp.’s Nations Funds unit, Bank One Corp.’s One Fund Group, Janus Capital Group Inc. and Strong Capital Management Inc. — have been charged with any wrongdoing, but Bank of America has fired six employees, one of whom also has been indicted on charges of grand larceny and securities fraud by Mr. Spitzer.”