A Petters fraud feeder fund, Palm Beach Capital Management with $1.6 billion of assets, is rushing to protect its asses before investors and regulators take a piece of the fund managers' hide. On Thursday investors in Bruce Prevost and David Harrold's Palm Beach Gardens-based hedge fund, received a letter to investors, which some recipients are now calling a delusional form of denial.

In an attempt to calm down an angry investor group who've been left in the dark about what's going on in winding down the fund, Steven Thomas the hedge fund's steering committee lawyer writes, "Although I have spoken to a number of you individually, I apologize for the lack of updates to the investor group."

Meanwhile Dealbreaker has seen copies of SEC communication that say the fund has been been investigated twice by the Dallas and Miami offices as far back as 2007 and accounts confirmed by an ex-employee of the firm. On Friday, another hedge fund that funneled all its money into the Petters ponzi scheme, called Lancelot Management, was charged for securities violation by the regulator. The fund's manager, Greg Bell, was also charged for not safeguarding how the money was being invested. Palm Beach's operating agreement, seen by Dealbreaker, was similar to Lancelot's in that they promised to 1) secure the money they lent with 'related inventory and the account receivables from inventory purchased' and and 2) make sure the guy financing the deal was really buying the goods. An action the SEC considers egregious is 'false assurances to investors.' Investors believe Prevost and Harrold are guilty of such a charge, having failed to perform their due diligence.

Calls to Prevost and Harrold were not returned for comment.

Robert Khuzami, Director of the SEC's Division of Enforcement, said, "Bell portrayed himself as a helping hand to investors.... But behind their backs, he was handing over billions of dollars of his client's money to feed a fraud." Investors who spoke with Dealbreaker on the condition of anonymity said they expect Palm Beach managers to be charged for securities fraud next and were frustrated that the firm's managing partners had never told them of the 2007 SEC investigation. According to one whistleblower, Laser Haas, the investigation was run by Luisa Lipins of the South Florida division but no wrong doing was found because the SEC didn't look into how false returns were being generated in Palm Beach Finance I and II. Instead, their regulator looked at another trade the firm made that involved diluting ownership when the firm took Manchester Inc. private. Sources inside the fund say the SEC came back at the end of 2008 after the Petters news broke.

An SEC investigator in the Lancelot case said he would not confirm or deny that Palm Beach is being investigated for involvement in the Petters fraud, even when confronted with their own letters of communication, but on note on their site states the Petters fraud investigation is still ongoing.

According to Palm Beach's investor letter, the general partners were going to return some of the investors' principle and agreed to a settlement but are no longer doing so because two investors individually sued for securities fraud. But according to three investors, no such settlement was realistic, and Prevost/Harrold need to charged with fraud in Florida so investors can go after their personal bank accounts and homes to get what they're owed.

Attorney Steven Thomas told Dealbreaker, "The funds victims should work together, not seperately, to recover the maxium amount of dollars." Thomas wouldn't discuss what other institutions or indivudals the funds general parterns could get money from.

SSR's attorney Guy Hohmann says, "The evidence is so overwhelming, you have to wonder whether Palm Beach fund managers were that incompetent, or they simply turned a blind eye towards Petters' activities."

Last week's investor letter also warned of bankruptcy and characterized the event as one that would have 'having positive consequences for investors.' Ironically, Palm Beach is the second largest creditor in the Petters bankruptcy with $1.05 billion in claims, a claim which has been objected to. Yet they boldly assure investors they'll get a seat on the creditors committee and expect to get some money out of the bankruptcy court. Also, in an attempt to appear independent, the fund hired a Chief Restructuring Officer named Lewis B. Freeman who they claim has experience getting money in large fraud cases. Sources say there is still $400 million left in firm assets, but it's held in other funds not affected by the Petters fraud.

Tom Petters was arrested for money laundering by the FBI last October and the SEC said there were $3.5 billion in losses for fund of hedge funds in his Ponzi scheme. For now, court proceedings in the Petters criminal case have been sealed - leaving the victims and the public with few answers about who else conspired in this maze of financial crime and abuse of investor confidence. One such person is a reformed convict turned multimillionaire Frank Vennes, who owns a spreads in Jupiter Island and Minnesota. Sources say Vennes met with Palm Beach's Prevost and Harrold several times in 2001-2002 at his Minnesota lake home to discuss how the managers would raise money solely to invest directly into Petters.

The first PB Finance fund was started in 2003 and grew to $250 million. The second fund began in 2004 with assets at the time of its shut down of $850 million - both were promoted by Jonathan Spring who raised institutional money for other big hedge funds such as Carrington Capital. The fund's operating agreements never discuss investing only with Petters. As late as November 2007, Spring sent a letter soliciting a chance to invest more in what were then closed Palm Beach funds. He wrote, "The risks of this strategy are relatively straight-forward and identifiable....risks I have thought carefully about for the past 4 years."

Vennes, Harrold, and Prevost have yet to be charged criminally for their involvement in Petters fraud. However, the MN US Attorney subpoenaed Vennes' emails when the feds reported that Vennes knew about the Petters Fraud back in 2007.

Earlier From Teri Buhl: The Real Money Is In Flipping Bank Charters, Not Houses

Teri Buhl is a Wall Street investigative reporter who written for the New York Post, Sunday Business, and HousingWire.com. Her big scoops include breaking news on all things wrong at IndyMac, calling out Bob Steel for lying to investors about losses on CNBC, and shinning a light on Wells Fargo for manipulating earnings with paper accounting gains. She resides in lower Fairfield County, CT.