Opinion | When dealing with money, check hedge fund's back office
Bernie Madoff knew where to hide his crimes, so that's where your due diligence on an operator should start if you want to avoid getting burned
The lure of high returns that aren't correlated to other markets has led to an explosion of global hedge fund money, to more than US$2 trillion. Unfortunately, "explosion" also describes a number of hedge funds that literally blew up over the years due to fraud or poor risk controls.
Hedge funds are typically managed offshore, outside the jurisdiction of local regulators. The funds use wide-ranging investing styles and ask for maximum flexibility from investors on the ways they can use their money. The managers of these often obscure, boutique funds move capital quickly from trade to trade, into many different accounts.
Any investor looking at a hedge fund has to ask the question - how do I know I'm not going to get ripped off?
When attempting to answer this question, most investors often focus exclusively on front-office issues such as a hedge fund's track record, investment team and strategy. They then get blindsided by mundane "back-office" issues, such as finding out the hard way there was only one person signing off on wire transfers, or that a fund didn't have a proper administrator.
The back office is the guts of the enterprise. Here operations and accounting staff manage complicated but tedious goings-on such as cash management, collateral, settlement and accounting.
It's also where most of the fraud happens. Because the operations are complex and convoluted, fraudsters can siphon off cash using false accounts, manipulated statements and fake trades, and bury everything in stacks of paperwork. Bernie Madoff did exactly that when pulling off his multibillion-dollar fraud, allegedly colluding with back-office staffers to hide his epic Ponzi scheme for more than a decade.