SAN FRANCISCO (Dow Jones) - Perry Capital could be sued by the Securities and Exchange Commission over a strategy that allowed the $10 billion hedge fund firm to influence the outcome of a merger without risking investment losses, the Wall Street Journal reported on Wednesday.

John Heine, a spokesman for the SEC, declined to comment and a phone message left at Perry's New York office wasn't immediately returned Wednesday afternoon.

Perry was a big shareholder in King Pharmaceuticals Inc. (KG)when rival Mylan Laboratories (MYL)offered to buy the drug maker in 2004. To vote for the deal, Perry bought almost 10% of Mylan shares, the WSJ said.

But Perry, formed by ex- Goldman Sachs (GS)investment banker Richard Perry, also used a number of hedging tactics to protect itself from losing money on the deal, including selling short an equal amount of shares that it held, the Journal reported.

The deal later collapsed amid litigation by a rival hedge fund run by billionaire financier Carl Icahn, who was a major Mylan shareholder and opposed the King deal, the newspaper added.

The SEC began investigating Perry's Mylan trading last year and the agency's Northeast regional office is now recommending that the hedge fund be charged with violating antifraud provisions of securities laws, the WSJ said, citing a letter Perry sent to investors this week.

Perry has the chance to explain to the SEC why action shouldn't be taken and told its investors that it has acted properly at all times, the Journal added. (END) Dow Jones Newswires 01-11-06 1704ET Copyright (c) 2006 Dow Jones & Company, Inc.