Make sure your Hedge fund has a custodian and administrator to avoid the next Madoff

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How to Avoid Getting Burned by the Next Bernard Madoff

By Laura Cohn
Kiplinger's Personal Finance
Sunday, January 4, 2009; Page F03
In light of Bernard Madoff's alleged Ponzi scheme, are you taking steps to ensure that your financial adviser is on the up and up?

A few basic checks can go a long way. Most important, know where your money goes when you hand it over. Whoever manages your portfolio should use an independent financial institution, known as a custodian, to hold your assets. Get the name of the firm and its contact information. Instead of relying on your adviser's word, check out the custodian yourself. And if your adviser is producing his or her own statements, as Madoff apparently was, watch out. "The presence of a custodian ensures that money from new investors can't be used to pay off old investors," says John Coffee, a financial expert and law professor at Columbia Law School.

Once you've established the bona fides of the custodian, find out which auditor your adviser uses. Then check the auditor, too -- particularly if the auditor works at a firm you've never heard of. Make sure the auditor is licensed to work in your state. Each state has its own database you can check. Having independent auditors is crucial because they verify the existence of the assets in your account and others your adviser manages.



Be particularly careful if your adviser has switched accounting firms recently and find out why. "When an adviser leaves an accounting firm, it might be because the accountants didn't feel comfortable with the adviser's financials," says Ken Springer, a former special agent of the FBI and president of Corporate Resolutions, which investigates money managers on behalf of hedge funds.

Once the custodian and auditor pass muster, gather information on the advisers themselves. Find out whether they have ever run into trouble. A good way to do that is to tap the Financial Industry Regulatory Authority, the industry's self-regulatory body.

FINRA has an easy-to-use broker check in the "Investors" section of its Web site. The National Futures Association has a similar tool on its site.

You also should make sure your adviser is registered with the proper regulatory agency. Advisers who manage more than $25 million must register with the Securities and Exchange Commission.

Those who oversee less than that have to register with their state. A state-by-state list of regulators can be found on the Web site of the North American Securities Administrators Association.