Hedge fund needs “prime brokerage” services to survive, including cleaning trade, managing risk, and providing leverage, renting office space and staffs (for some) .
In terms of the regulation control, risk is one of the major concerns; misuse of leverage can increase risk. However, in terms of fraud, renting office space and staffs for some hedge funds sometimes creates an image of conflict of interest, which leads fraud.
Leverage can be a sword that can cut both ways. If the market move is in the same direction as what PMs expect, it can increase profit dramatically. However, if the trend is reverse, it can bring down the house in a few trading days due to the ownership of not-owning.
For conflict of interest, the brokers might office services with conflict of interest to attract hedge funds to continue lease the corner or premium office space and staffs to increase revenues. If there is conflict interest involved, it is hard to keep the attraction away. If conflict of interest is tied squarely with revenue, it might lead to fraud.