NEW YORK (CNNMoney.com) - From fines to frauds to proxy fights to rocky returns, the press-shy hedge fund industry grabbed more headlines in 2005 than it has since 1998, when the spectacular blowup of a fund called Long Term Capital made "hedge fund" a household word. Since then, strong performance and other factors have helped these funds rack up $1 trillion in assets worldwide. The industry has swelled to an estimated 8,000 funds, attracting new investors such as endowments and pension plans along the way. Here are the top hedge fund stories of the year:

Bayou blows up

Bayou Group founder Samuel Israel III, scion of a New Orleans commodity trading family, and Daniel Marino, the fund's chief financial officer, pleaded guilty to defrauding investors of $450 million over several years simply by lying to them about how much money the funds were producing and setting up a phony auditor to sign off on the cooked books.

The tale produced news reports containing sordid details such as a six-page suicide note and confession from Marino, who didn't kill himself, and allegations that Israel had a drug problem and threatened his partner with a gun. While Israel and Marino await sentencing in January, investors are trying to get their money back. Numerous class-action suits are hitting court dockets, filed by investors suing third-party firms who invested in Bayou on their behalf.

Tough October; lackluster year

October proved to bethe worst single month for hedge funds in many years, with even typically strong performing managers posting losses in the high-single digits. For some, the month wiped out the modest gains managers have made in what has proved to be a difficult year for getting strong returns. "Performance was terrible," said Daniel Strachman, managing partner of financial services firm Answers & Company Group and the author of "Getting Started in Hedge Funds."

Strachman believes the mediocre performance has also affected funds of funds, or managers who invest in a portfolio of hedge funds on behalf of clients for an additional layer of fees. But a snap-back in November, coupled with what many believe will be a strong December, could lift hedge fund returns out of their doldrums. If that happens, it would be a repeat of 2004, in which many hedge funds racked up their gains for the year during the final quarter.

Rise of "activist" managers

Whatever you call them – shareholder activists, corporate raiders, saber-rattlers – hedge fund managers who battle corporate managements in the hope of boosting target companies' stock prices generated headlines and also cash as the hedge fund style du jour. And they're taking on big targets. Famed agitator Carl Icahn, who launched his hedge fund late last year, rounded up a cartel of investors, including fellow activists Jana Partners, to take on behemoths like Time Warner. (Time Warner is the parent company of CNNMoney.com) Meanwhile, Bill Ackman's activist fund Pershing Square Partners has taken on a corporate behemoth of its own in agitating for change at McDonald's.

The race to registration

While hedge funds have known for more than a year that many of them will be required to register with the Securities and Exchange Commission, some un-registered managers are evaluating their options for not having to comply with the rule, which takes effect in February 2006. The SEC is not requiring managers who "lock up" their investors' capital for two years or more to register and is also giving a pass to firms who agree not to take in new money.

Said Jedd Wider, a partner in the private investment fund practice at law firm Orrick, Herrington & Sutcliffe, "Most of our clients who are required to register have gone through the process already; others are giving very serious thought to extending their lockup periods or looking to close their funds to new investors."

Meanwhile, hedge fund manager Phillip Goldstein, who is suing the SEC on the grounds that the SEC exceeded its regulatory authority, got a short-term boost to his case Friday when U.S. appeals court judge Harry Edwards, one of three judges hearing arguments in the suit, told an SEC attorney the agency stretched the definition of "hedge fund clients" to make the registration proposal work, according to news reports. The panel will issue a verdict in about three months – after the rule will have already gone into effect -- Goldstein's attorney told the Chicago Tribune.

Overstock, Rocker Partners, and the "Sith Lord"

What started out as a brief, straightforward civil complaint rapidly spun into a circus sideshow as Patrick Byrne, chief executive of online closeout retailer Overstock.com, accused famed short-seller David Rocker of conspiring with independent research firm Gradient Analytics to drive down Overstock.com's share price. Byrne filed suit against both firms and their principals, but his bizarre publicity junket soon overshadowed the contents of the suit.

In a conference call to investors and reporters, Byrne launched into a rambling diatribe in which he accused hedge fund managers, journalists, and a well-known Wall Street figure, whom he would not name but instead dubbed the "Sith Lord, " of conspiring to drive the company's stock price down. Rocker and Gradient filed a motion to dismiss the suit, and Rocker founder David Rocker told Fortune he is preparing to file a countersuit.

Automaker downgrades lead to losses

When two bond-rating agencies this summer cut General Motors' corporate bonds to junk, some hedge funds, as well as some investment banks, suffered heavy losses. Particularly hard hit were funds that were shorting the common stock of GM and holding long positions in the underlying bonds. When the bonds got downgraded, investors were forced to try to sell into a market with no buyers; meanwhile, investor Kirk Kerkorian announced he would acquire a large stake in GM, causing a price spike in the stock. While the debacle did not force any large funds to unwind, the events sent jitters throughout the markets.

A once-dependable strategy falters

Once considered a safe, conservative strategy, convertible bond arbitrage, in which managers buy convertible bonds and short the underlying stock, proved to be the worst performing hedge fund strategy this year, and the plunge caused some large convertible arbitrage hedge funds to close, including Marin Capital Partners, which had $2.2 billion in assets at its peak, and Alta Partners, run by Creedon Keller & Partners, which had about $1.2 billion at its peak. The rout began late last year, when investors in these funds, unimpressed with a streak of lackluster returns, began asking for their money back. The redemption requests forced managers to sell into a market with no buyers, which drove returns even lower. Convertible arbitrage funds are down 2.69 percent for the year to date through November, according to Chicago-based hedge fund tracker Hedge Fund Research.

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