What can investors do to protect themselves from unscrupulous hedge-fund managers?
The well-publicized collapse of two hedge funds - Bayou Management and Wood River Capital Management - has made this an important question for investors. According to BusinessWeek, about 10% of hedge funds that raise "red flags" - and these are the ones investors should avoid.
Before investing in any hedge fund, first check out the fund manager's credentials as well as the fund's claims, to make sure, for instance, that the fund manager is indeed the person he claims to be.
Make sure the fund has undergone a recent independent audit. Also check to see if its investment strategy is right for your portfolio and investment goals.
You may also want to do an online search of court judgments, tax liens and other information about the principles and the fund. Obviously, if you find clear red flags - such as recent bankruptcies, criminal convictions or tax judgments - you will probably want to avoid the fund.
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Here are some ways to check out a hedge fund in advance. Fees range from free to several thousand dollars:
1. Check public records for FREE at (www.pretrieve.com.) This is the minimum search that all potential investors should conduct.
2. Search federal district, bankruptcy and appeals court records at (www.pacer.psc.uscourts.gov.) The cost is $0.08 per page.
3. Find employment and disciplinary records of brokers who work for an NASD member firm at (www.nasdbrokercheck.com.)
4. Search for lawsuits filed by the Securities and Exchange Commission (SEC) at (www.sec.gov.)
5. Search for federal court convictions and pending lawsuits at (www.uscourts.gov/courtlinks.)
6. Thoroughly examine any legal actions against either the fund principles or the fund itself at (www.lexisnexis.com.) This is a paid service.
7. Search for state regulatory violations at (www.nasaa.org/QuickLinkis/ContactYourRegulator.cfm.)
8. Ask to see copies of background checks commissioned by the fund. You may need to look at the fund's copies of these reports in person at their offices.
9. Hire an independent hedge fund detective to do a thorough search on both the principles and the fund. Fee: $1,000 and up.
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