Hedge Fund Due Diligence

Due diligence into hedge funds is not an easy thing. It is a detailed process that can take quite some time -- from examining the manager's past and references to doing background checks on the staff, it's a necessity that you go through every person in the office to make sure that they are qualified and that your money will be protected.

But what about everyone else who works for your hedge fund? You covered the IT guy and the new kid in the mail room, but did you check on the prime broker? Did you call up the auditor? How far does your due diligence go?

Hedge funds work with a large number of outside vendors. From brokers and compliance consultants to fund administrators and marketers, they have a wide range of people who they will call on to assist in running the fund. You need to make sure that you know who works with your fund, and you need to make sure that you are comfortable with them as well.

According to Douglas Dick, a partner at Dechert, LLP in Newport Beach, the first place to start in gathering information is the offering memorandum. In it, a hedge fund will disclose who their outside support vendors are. These include law firms, fund administrators, outside compliance companies, and independent auditors. What it won't disclose are some of the smaller details, such as who their technology vendors are. And he identifies the first red flag in this part of the process -- when you ask the question and the fund isn't willing to answer it. When you are preparing to invest a large sum of money, it is important that you fully trust the person who will be receiving the funds.

There are a few reasons why this step is important. The first is to make sure that the fund you are investigating is in good standing. Many of the hedge fund frauds that are perpetrated include forged audit statements, and sometimes even include made-up accounting firms. A simple call to the auditor will tell you if the statement that you are reading is...