ALL BUSINESS: Amaranth\'s Object Lessons

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However, those gains evaporated as futures prices for natural gas plunged this summer, including a 12 percent decline just last week, after a milder-than-expected winter allowed supplies to surge and this year's hurricane season has so far had no impact on production. On Thursday, the most actively traded futures contract traded below $5 for 1,000 cubic feet of natural gas.

Note:  1,000 cubic feet of natural gas refer to one mmBtu using in futures contract of natural gas

"This showed a lack of adherence to their defined leverage and exposure tolerances, which allowed them to become susceptible to the downturn in this very volatile market," said Brian Shapiro, principal at CarbonBased Consulting, which provides research and advisory services to hedge funds and investors.

If regulators don't step up, then investors must take the initiative to protect themselves. That means doing extensive due diligence on funds - inspecting everything from operational procedures to marketing to corporate culture - not just before the investment is made but for the duration of the relationship.

A recent survey by CarbonBased Consulting of 30 hedge fund marketers, which advise clients on fund investments, found that all of the respondents put performance as the most important issue, while only 12 percent bothered to back check how fund managers earned their money.

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Earlier this year, Harry Arora, a former Enron Corp. energy trader who had hired Hunter at Amaranth, had a falling out with Maounis and Hunter over the risks the firm was taking, say people familiar with the situation. Maounis, impressed that Hunter made hundreds of millions of dollars for the firm in 2005 after Hurricane Katrina sent natural gas prices soaring, made the young Canadian a co-head of commodities trading.

In addition, he let Hunter increase the size of his natural gas positions so that they became more than half of the entire firm's exposure, even though Amaranth claimed to be a "multistrategy" fund. Before Hunter's arrival, all commodities positions made up about 20 percent of Amaranth's portfolio, natural gas no more than 7 percent.