Background checks on hedge fund managers are coming under more scrutiny, as part of an increasing overall focus on due diligence. Background checks are no longer just "window dressing," something that can be put into the marketing documents, noted Brian Reich, president of Atrato Advisors, an advisory firm in New York. Instead they reflect a genuine concern about what may be found, a wish to "find that needle in the haystack."
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| Randy Shain |
Randy Shain, executive vice president at First Advantage Litigation Consulting in New York, said that smaller funds of funds, particularly those that manage fewer than $1 billion, have realised that "to play with the big boys [...] the phrase 'I can't afford it' has turned around to 'I can't afford not to.'" Increasingly they are outsourcing background checks on hedge fund managers as part of a more thorough due diligence process, where in the past the checks were done internally but in reality given short shrift. First Advantage conducts independent background checks on hedge fund managers on behalf of their investors.
"Post-[Bernard] Madoff customers are now coming back and reinvestigating managers they've already investigated," said Guy Simonian, ceo of Check Fund Manager, a due diligence firm. Simonian has seen an uptick in renewal requests and as a result the firm has developed systems to monitor managers on an ongoing basis.
While investors are nervous because they realise that historically their efforts in this area have been inadequate, a larger consideration is to make themselves "lawsuit proof," said Shain. Relying on the regulator, or on internal security, "is not going to cut it anymore," and investors are conscious of making themselves aware of freely-available information, so they can say, "it's not likely we sleepwalked through this whole thing."
Background checks are "most useful for the smaller manager that fewer people know about," noted Reich, as a larger manager of a well-established hedge fund "has been fairly well vetted by the time you get to him." He added, "It's the smaller guy, the startup with friends and family money" that needs closest inspection.
Simonian agreed with Reich but affirmed that all managers still need to be investigated. "As Madoff proved, just because you're a large well-established firm doesn't mean that greed has gone away."
When the outcomes of the abundance of current fraud-related lawsuits gradually surface it will be interesting to see what due diligence standards the funds of funds can be held to, Shain told AIN. "Can the dumb defence work," he asked, the plea that the defendant was "too stupid to know where to look?" It is a stronger defence than saying "we found this information and we invested anyway" or "we looked and we didn't find anything," he added.
"Professional investors are coming under a tremendous amount of pressure to do the work," observed Reich, as "people lost a lot of money [...] from laziness." The increased onus on background checks forms part of "a very important component of a larger idea of doing the work." --H.A.
This article was originally published in Alternative Investment News.