Hedge-Fund Investors Hire Private Eyes to Avoid New Madoffs - Madoff Fraud

Hedge-Fund Investors Hire Private Eyes to Avoid New Madoffs

By Saijel Kishan

March 23 (Bloomberg) -- Randy Shain said he wasn’t stunned when hedge-fund managers Paul Greenwood and Stephen Walsh were arrested last month for allegedly misappropriating $554 million in client funds.

A probe three years ago by his First Advantage Investigative Services LLC found in public documents that a brokerage run by the pair had agreed to settle regulators’ claims that it improperly used customer assets as loan collateral and had been fined at least 11 times for violating rules at several U.S. exchanges. The firm neither admitted nor denied the allegations, which covered actions from August 1985 to January 1986.

“It’s a case of turning over the stones and finding what’s underneath,” said Shain, who doesn’t know if the client of his New York-based firm steered clear of the fund managers.

Firms like Shain’s say they are seeing an increase in requests for background checks on fund managers in the wake of high-profile fraud cases against Bernard Madoff in New York, Florida’s Arthur Nadel and R. Allen Stanford and his Antigua- based bank. In all, the men are accused of cheating clients out of as much as $73 billion.

“Investors are being more careful in checking out where they put their money,” said Pete Turecek, a senior managing director overseeing hedge funds at Kroll Inc., a risk-consulting company in New York “As the economy continues to weaken, some people including money managers may be drawn to taking shortcuts.”

‘Really Fruitful’

Sharath Sury, whose S4 Capital LLC oversees $2 billion in assets, hired an investigative firm three years ago to look into a hedge fund before making a planned investment.

Sury said the probe revealed that the New York-based fund, which had $600 million in client assets, didn’t reconcile trades daily as the manager had claimed, reported inconsistent asset values and used an auditor related to its founder. The fund shut down in 2007, he said, declining to name the firm.

“This was a case of the background checks proving to be really fruitful,” said Sury, chief executive officer of Chicago-based S4 Capital. “It helped us avoid major losses.”

Investigators trawl through court filings and public databases such as LexisNexis and interview former employees to get information on managers that may raise concerns. They dig up records of violations of trading rules, faked resumes, drunk- driving offenses and drawn-out divorce cases.

$1,000 Cost

Background checks can take from two to six weeks, and may cost about $1,000 for each individual or company investigated, according to the firms.

“Basically you don’t want managers to have distractions that will impact their decision making,” said Michael Dubin, president of New York-based The LongChamp Group Inc., which allocates client money to hedge funds.

Background searches helped Cole Partners Asset Management LLC stay away from managers that were later found to have had run-ins with regulators, said Rian Akey, chief operating officer of the Chicago-based firm, which channels money into hedge funds.

Akey said a check done three years ago on a New York-based hedge fund found that in 1999 the managers had paid fines amounting to $500,000 for violating trading rules. “That was enough to put us off,” he said, declining to name the fund.

Public records show that Nadel, founder of Scoop Management Inc. in Sarasota, Florida, was disbarred as a lawyer in New York in March 1982. Nadel faces federal charges of defrauding investors of more than $300 million.

Undetected for Decades

Madoff fooled clients and regulators for decades as he used money from new investors to pay off old ones. Fairfield Greenwich Group, Tremont Group Holdings Inc. and Bank Medici AG were among victims that channeled client money to Madoff’s firm.

Harry Markopolos, a former money manager, told Congress that he had tried to convince the agency for nine years that Madoff was a fraud. Madoff, 70, pleaded guilty last week to defrauding investors of as much as $65 billion in the biggest Ponzi scheme in history. He will be sentenced on June 16 and faces 150 years in prison.

“There is now a rethinking of diligence practices,” said Mitch Nichter, a partner at Paul, Hastings, Janofsky & Walker LLP, a New York-based law firm. “This will translate into enhanced efforts to verify information provided by hedge funds.”

Not all investors hire outside firms to perform background checks. In-house teams can do the same work, says Cem Habib, portfolio manager at London-based Altedge Capital Ltd., which invests in hedge funds.

“In addition, we have an extensive network of people in the industry that we can speak with to check up on other people’s backgrounds if we need to,” he said.

Driving Records

Fraudulent activity is not the only thing that can be unearthed in investigations. Drunken driving can highlight character issues, according to Kroll’s Turecek.

“It may signify an inability to handle stress properly,” he said. “We look for patterns of behavior that may be indicative of a larger issue or of someone’s character.”

A background check on a New York-based hedge fund in 2005 found that one of its analysts had recently resisted arrest after being caught shoplifting, according to Jeff Brenner, a principal at Intelysis Corp. in Cherry Hill, New Jersey. The analyst was due to appear in court a week before the Intelysis client was about to put money in the fund, he said.

“At the end of the day he’s helping to determine where money is being invested,” said Brenner, whose firm has done more than 500 hedge-fund investigations since 1998.

Allegations in divorce filings, such as adultery with a co- worker, can also raise red flags, said Turecek.

“Such situations may warrant looking at the individual’s expenses to see if there were improperly charged to the company.”

To contact the reporter on this story: Saijel Kishan in New York at skishan@bloomberg.net

Last Updated: March 22, 2009 20:11 EDT