The Daily Caveat is written by Michael Thomas, a recovering corporate investigator in the Washington, DC-area.

CARE TO CONTRIBUTE?

TIPS, COMMENTS and QUESTIONS are always welcome (and strictly confidential).

Contact The Daily Caveat via:



Join our mailing list to new posts via email.



Or justrss icon read the feed...


Previous Posts
8/09/2005
Investigating Hedge Funds
An interesting article from the Wall Street Journal follows, describing the growing role of the corporate investigative sector in assessing and evaluating Hedge Funds individual-investor clients as well as larger institutions. Based on their capacity for rapid returns, hedge funds have become a tempting investment choice for many, but their sparsely regulated nature and the infrequent horror story in the financial press leaves potential investors sometimes feeling unsure of how to separate the reputable from the reprobates. That's where we come in:

Digging for hedge-fund dirt

August 08, 2005
By Jane J. Kim
The Wall Street Journal

The exploding popularity of hedge funds is creating a boom for modern-day corporate sleuths, who are doing big business digging into these secretive investment vehicles and their managers. The investigative firms range from large, multinational companies such as Kroll Inc., a unit of Marsh & McLennan Cos., to smaller shops with just a handful of private investigators. Though their biggest clients are institutional, a growing number of wealthy investors and their family offices also are looking for information.

The costs of these reports can range from roughly $1,000 to check out a one-manager hedge fund to tens of thousands of dollars for an in-depth, detailed report on a fund with multiple managers and world-wide operations. The investigators typically are former law-enforcement agents, licensed private investigators, forensic accountants and investigative journalists.

Because hedge funds -- lightly regulated investment pools that employ a wide range of strategies and are geared to institutions and the wealthy -- aren't subject to many of the reporting requirements that apply to mutual funds, it can be difficult to get details about their assets, returns and the people who run them. Assets in hedge funds are estimated to have more than doubled to about $1 trillion during the past five years, while the number of hedge funds has swelled to more than 8,000.

There have been some high-profile blowups recently, such as KL Financial Group, a Palm Beach, Fla., hedge fund that shut down amid an investigation by regulators of allegations that it reported outsize returns while actually losing money. In the five years through 2004, the Securities and Exchange Commission brought 51 cases against hedge-fund advisers who, it asserted, defrauded investors of more than $1.1 billion.

For many investors, checking out a hedge-fund manager used to be as simple as making a few discreet calls to well-placed friends at Wall Street firms. But as more money and new players flood the industry, returns -- in the 20 percent-plus range a decade ago -- have moved closer to those of stocks and bonds. In their quest for higher returns and innovative strategies, investors increasingly are seeking out international hedge funds or managers with nontraditional backgrounds, making the usual means of gathering information more difficult, experts say.

Investigative firms verify the manager's credentials and scour public records, such as news sources, company documents, regulatory filings and court documents, including criminal filings, bankruptcy records and civil lawsuits. Though some searches have turned up outright crooks, most discoveries are more mundane: managers who padded their resumes or failed to disclose jobs that went bad. (One investigative firm found that a fund manager was banned from the national parks for indecent exposure.)

But sometimes managers have had run-ins with securities laws. Tax liens, prior bankruptcies or other signs of financial difficulties are often deal breakers for potential investors. Even evidence of an active social life can deter potential investors who worry that the person may not be singularly focused on managing the fund.

"Unlike your friends, who you want to be Renaissance men, in a hedge-fund manager you're looking for the guy that doesn't have a personality," says Randy Shain, executive vice president at First Advantage Corp.'s First Advantage CoreFacts LLC investigative unit, which produces BackTrack Reports."People who have spent a lot of time doing a lot of other things, like auto racing, means that they're away from a computer screen."

Investigative firms estimate that between 10 percent and 20 percent of their searches will turn up suspicious information. But many say that percentage has been increasing as investors flock to more exotic funds and nontraditional managers.

Whether the information that a search turns up is enough to quash a potential investor's interest in the fund depends on the investor. Some will balk if a "white lie" pops up on the manager's resume, whereas others may be reluctant to walk away after spending a significant amount of time and money looking into the fund, even if faced with evidence of criminal activity. That is especially true if the criminal conviction was long ago or if the type of activity, such as drunken driving, isn't considered "material" by the investor, says Jeff Brenner, principal at Intelysis Corp., a corporate-fraud investigation firm. "It's a character flaw, I suppose, but not one (of) business acumen."

To be sure, institutional investors such as pension funds, endowments and so-called funds of hedge funds -- which bundle stakes in different hedge funds into one investment -- conduct a fair amount of due diligence on their own, analyzing investment strategies and delving into performance. But they are increasingly relying on outside investigators to look further into a manager's background.

Some consultants and investigators, such as London-based Control Risks Group and Capco, a unit of Capital Markets NV of Belgium, also look at whether assets reported to investors, as well as the methods used to value those assets, are accurate. That is a growing concern as hedge funds have become more complicated, with multiple managers investing in increasingly hard-to-value securities, such as credit derivatives. And as more hedge funds seek control of companies through private-equity deals, they themselves are hiring investigative firms to vet the directors or management.

The Financial Investigation Services division of NCO Financial Systems Inc., a unit of NCO Group Inc., says hedge funds now make up about 30 percent of the division's revenue, up from about 8 percent three years ago. The division's private investigators are spending more time delving into the backgrounds of hedge-fund managers in Asia, Europe and the Middle East as U.S. investors look overseas for higher returns, and hedge funds set up shop in countries with less regulation. About 12 percent to 15 percent of the division's revenue now comes from overseas projects, up from less than 5 percent five years ago.

The original article apears here. For more on all things hedge fund, check out our friends at FundStreet.org.

-- MDT

Labels: , ,

0 Comments.
Post a Comment


all content © Michael D. Thomas 2010