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Spotting hedge fund fraud

Date: Tuesday, April 30, 2013
Author: Fiona Collie, Investment Executive

Frank Casey, who helped blow the whistle on Bernard Madoff, offers four T.I.P.S. to identify fraud

The due diligence that can stop an investor from misplacing their trust and their money with a fraudster doesn't have to be difficult, according to Frank Casey, co-founder, managing partner, Vintage Investment Partners in Boston.

Speaking at the Canadian Alternative Investment Forum in Toronto on Thursday, Casey offered four steps of due diligence that will identify fraud.

"I came up with this anagram T.I.P.S.," said Casey. "What I love about it is that three-quarters of it is qualitative. Family offices can do it on their own, any investor can do it on their own."

Casey was one of a group, called the "Fox Hounds" who blew the whistle on Bernard Madoff's Ponzi scheme, which collapsed in 2008.

Here are Casey's T.I.P.S for identifying possible hedge fund frauds:

> T Third-party verification
Investors need to make sure the hedge fund has third party auditors and custodians.

"Madoff was the broker, the manager, the custodian, the administrator," said Casey, "Everybody wanted a piece of this guy and they were willing to ignore the fact that he was his own custodian."

> I Internal controls
The head manager and chief financial officer (CFO) should always be separate, according to Casey. If it is a small firm then they should have a third-party CFO.

> P Pedigree
Investors need to research hedge fund managers and their teams, according to Casey, to make sure they actually have the credentials and experience they claim. Investors and family offices should even go so far as to hire a private investigator.

"I want to see the pedigree of the manager," said Casey, "but also the sub-managers and everybody they're doing business with."

> S Strategy
Study the manager's strategy to look for results that are simply too good to be true. This step requires some knowledge of the markets and how they work.

Casey suggests finding managers that find opportunities in the market but that also eventually lose those same openings.

"Always look for where the capital markets are inefficient," he said, "because if you can find a management team that can exploit that inefficiency and they've got a tailwind behind it they will eventually trade themselves into efficiencies."