Red flags at hedge funds that worry experts

(Reuters) – As the hedge fund industry reels from news that investor Bernard Madoff allegedly committed a $50 billion (33 billion pound) fraud, forensic accountants, former prosecutors and private investigators list some potential red flags at hedge funds that might indicate irregularities and should make investors take notice and probe further.

* Returns that seem too good to be true. Bernard Madoff reported that his portfolio suffered only 5 months of losses out of 156 months. If a fund is reporting spectacular returns at a time most of the industry is suffering, industry experts urged investors to be skeptical and dig below the top line numbers.

* Using law firms, accountants or bankers that are not well-known. Samuel Israel’s failed Bayou Group created a fake accountant. Madoff used a small, unknown accountant.

* Sudden delays in getting information: If monthly statements arrive much later than usual or not at all, experts said it is time to ask more questions. Madoff sent his statements by mail not email the way most funds do to let investors make comparisons more easily.

* Rebuffing investors who demand more information. Madoff declined to say much about his strategy telling people who wanted to find out more they were wasting their time.

* Implausible excuses for delays in getting information: If managers say their computer systems have been down for days and they ignore email messages, experts said they would worry.

* Stonewalling requests to visit: This could mean the managers sold off all the office furniture and left behind a receptionist to answer calls.

* A sudden wave of departures: Experts suggest interviewing people who left because they might know if anything unusual is going on.

* A sudden drop in minimum investment requirements, something that happened with Madoff.

* A sudden shift in investment philosophy: If your long/short equity hedge fund suddenly dabbles in commodities and waits weeks to tell you about it, start to worry, the experts said.

* Big unexplained expenses: Question any sharp moves in management fees or other things. It could indicate managers might be funneling money elsewhere, the experts said.

* An inordinate amount of extremely expensive toys: Industry experts said a spending spree on antique Ferraris might be worrying unless the managers are extremely successful and wealthy.

* Building of enormous first or second homes: Industry experts worry the manager might spend more time thinking about drapes than his investment positions.

* Divorce: This could be very messy, industry experts said, adding a breakup could cost the manager a lot of money and emotional energy.

* Inappropriate experience among managers: Check resumes and references carefully, industry experts said warning, for example, that recent college graduates or even economists at Wall Street banks might not have the requisite experience to run a hedge fund.

(Reporting by Svea Herbst-Bayliss and Jennifer Ablan; Editing by Andre Grenon)

Mon Dec 15, 2008 9:16am EST

Source: Reuters

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