Articles By Topic
By Topic: Background Checks
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From Vol. 5 No.26 (Jun. 28, 2012)
Delaware Chancery Court Decision Highlights the Imperative of Thorough Due Diligence on Potential Hedge Fund Business Partners
As a hedge fund manager, you are required as a legal matter to “know your customers,” that is, your investors. In addition, you are required as a practical matter to know your partners. In many cases, this imperative is beside the point: many hedge fund management businesses are founded by partners that have been working together for years. In other cases, however, management companies are organized by partners that met only recently. In such cases, the partners should perform thorough due diligence on one another. It may seem contrary to the optimism, trust and team spirit required to scale the increasingly high barriers to beginning in the hedge fund business. But a recent Delaware Chancery Court (Court) opinion highlights the fact that the stakes are too high to rely on gut feelings. The stakes are even too high to rely on routine due diligence conducted by credible service providers. The stakes are nothing less than your personal reputation, and in the investment management business, that is all you have or can have. Diligence in this context should be deep, customized and cross-checked. Once you get into bed with a bad actor in the investment management business, it is virtually impossible – from a reputation point of view – to get out.
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From Vol. 4 No.42 (Nov. 23, 2011)
Private Lawsuits Against Hedge Fund Managers Can Be Important Sources of Examination and Enforcement “Leads” for the SEC
On November 10, 2011, the Securities and Exchange Commission (SEC) announced the simultaneous filing and settling of charges against investment adviser Lilaboc, LLC d/b/a ThinkStrategy Capital Management, LLC (ThinkStrategy) and its founder and managing director, Chetan Kapur (Kapur, and together with ThinkStrategy, Defendants). The SEC’s Complaint in the action (Complaint) alleges that over nearly seven years the Defendants made false statements to investors in ThinkStrategy Capital Fund (Capital), a hedge fund managed by the Defendants, and TS Multi-Strategy Fund (Multi-Strategy, and together with Capital, Funds), a fund of funds managed by the Defendants. Those allegedly false statements related to the Funds’ performance, longevity and assets under management (AUM), as well as the credentials of Kapur and his management team. Moreover, with respect to Multi-Strategy, the Complaint alleges that the Defendants failed to perform due diligence commensurate with their representations to investors before investing with underlying managers. As a result of such inadequate due diligence, Multi-Strategy invested in notorious Ponzi schemes such as Bayou, Valhalla/Victory Funds and Finvest Primer Fund. See “Recent Bayou Judgments Highlight a Direct Conflict between Bankruptcy Law and Hedge Fund Due Diligence Best Practices,” The Hedge Fund Law Report, Vol. 4, No. 25 (Jul. 27, 2011). Allegations in the SEC action incorporate and expand upon allegations in a private civil action recently filed against the Defendants, and – as discussed more fully in this article – highlight the interaction between private claims and SEC enforcement actions. See “Federal Court Decision Holds that a Fund of Funds Investor May Sue a Fund of Funds Manager That Fails to Perform Specific Due Diligence Actions Promised in Writing and Orally,” The Hedge Fund Law Report, Vol. 4, No. 27 (Aug. 12, 2011).
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From Vol. 4 No.41 (Nov. 17, 2011)
SEC Commences Fraud Action against a Purported Hedge Fund Manager for Providing False Background Information and Including False Information on a Website
On October 26, 2011, the Securities and Exchange Commission (SEC) filed suit against Andrey Hicks and the hedge fund manager he ran, Locust Offshore Management, LLC (LOM), alleging that they defrauded investors by fabricating the existence of a British Virgin Islands-incorporated pooled investment fund. The SEC’s complaint (Complaint) also names the purported fund, Locust Offshore Fund, Ltd. (LOF), as a relief defendant. The Complaint, among other things, sheds new light on an old due diligence verity – the imperative of thorough background checks. See “In Conducting Background Checks of Hedge Fund Managers, What Specific Categories of Information Should Investors Check, and How Frequently Should Checks be Performed?,” The Hedge Fund Law Report, Vol. 2, No. 36 (Sep. 9, 2009).
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From Vol. 4 No.25 (Jul. 27, 2011)
Recent Bayou Judgments Highlight a Direct Conflict between Bankruptcy Law and Hedge Fund Due Diligence Best Practices
The United States District Court for the Southern District of New York recently issued judgments in favor of three bankrupt hedge funds in fraudulent conveyance actions against investors that redeemed within two years of the funds’ bankruptcy filings. The hedge funds were members of the Bayou group of hedge funds, which – as the hedge fund industry knows well – was a fraud that collapsed in August 2005, resulting in bankruptcy filings by the Bayou funds and related entities in May 2006. These judgments are very important for hedge fund investors because they illustrate what appears to be a direct conflict between bankruptcy law and hedge fund due diligence best practices. In short, hedge fund due diligence best practices currently counsel in favor of redemption at the first whiff of fraud on the part of a manager. However, bankruptcy law appears to require a hedge fund investor to undertake a “diligent investigation” when it obtains facts that put it on inquiry notice of insolvency of the fund or a fraudulent purpose on the part of the manager. The immediacy of a prompt redemption is directly at odds with the delay inherent in a diligent investigation. How can hedge fund investors reconcile the practical goal of prompt self-help with the legal obligation of a diligent investigation? To help answer that question, this feature length article surveys the factual and procedural history of the Bayou matters, then analyzes the arguments and outcome in the recent Bayou trial. The primary question at the trial was whether certain investors that redeemed from the Bayou funds could keep their redemption proceeds based on “good faith” defenses to the Bayou estate’s fraudulent conveyance actions. In the absence of a court opinion, The Hedge Fund Law Report analyzed the 142-page transcript of the closing arguments, as well as the motion papers filed by the parties and four prior bankruptcy court and district court opinions. This article embodies the results of our analysis. The article concludes by identifying five ways in which hedge fund investors may reconcile hedge fund due diligence best practices with the seemingly draconian outcome in these recent Bayou judgments.
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From Vol. 4 No.22 (Jul. 1, 2011)
What Hedge Fund Managers Need to Know About Information and Data Security
While hedge fund executives are experts at identifying and managing the risks relating to their financial assets and portfolios, they generally do not have the time or expertise to focus on the security of their people and intellectual property assets. However, all organizations – especially financial institutions – must be prepared for the inherent risks and responsibilities associated with doing business in an online world through a sound digital risk management strategy. The appropriate approach to digital risk management varies from firm to firm based on unique business models and requirements. However, all hedge fund managers should take a risk-based approach to security and ensure that the approach is aligned with the way executives manage other business issues. While physical security and information security present different challenges, they are strongly related, are part of internal controls and should be managed using an integrated strategy. In a guest article, Edward Stroz, Co-President of Stroz Friedberg, a digital risk management and investigations firm, and Steven Garfinkel, Vice President of Stroz Friedberg’s Business Intelligence & Investigations Division – and both former FBI Special Agents – outline the most critical aspects involved in implementing a digital risk management program for hedge fund managers.
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From Vol. 2 No.52 (Dec. 30, 2009)
Why Are Most Hedge Fund Investors Reluctant to Sue Hedge Fund Managers, and What Are the Goals of Investors that Do Sue Managers? An Interview with Jason Papastavrou, Founder and Chief Investment Officer of Aris Capital Management, and Apostolos Peristeris, COO, CCO and GC of Aris
An article in last week’s issue of The Hedge Fund Law Report detailed a ruling by the New York State Supreme Court permitting a lawsuit by funds managed by Aris Capital Management (Aris) to proceed against hedge funds in which the Aris funds had invested and the managers of those investee funds. See “New York Supreme Court Rules that Aris Multi-Strategy Funds’ Suit against Hedge Funds for Fraud May Proceed, but Negligence Claims are Preempted under Martin Act,” The Hedge Fund Law Report, Vol. 2, No. 51 (Dec. 23, 2009). That lawsuit is one of various suits brought by Aris and its managed funds against hedge funds or managers in which the Aris funds have invested. The Aris suits allege a variety of claims in a variety of circumstances, but collectively are noteworthy for their mere existence. In the hedge fund world, there has been a conspicuous absence during the past two years of legal actions by hedge fund investors against hedge fund managers, despite the coming-to-fruition of circumstances that industry participants thought, pre-credit crisis, would augur an uptick in litigation: the imposition of gates, suspensions of redemptions, mispricing of securities, large losses, etc. Jason Papastavrou, Founder and Chief Investment Officer of Aris, appears to have broken ranks with what seems like an unspoken agreement in the hedge fund world to avoid the courthouse steps, and he has done so with a considerable degree of thoughtfulness, for specific reasons and with particularized goals. In an interview with The Hedge Fund Law Report, Papastavrou and Apostolos Peristeris, COO, CCO and GC of Aris, discuss certain of their lawsuits, why they brought them, what they seek to gain from them and what the relevant managers might have done differently to have avoided the suits. They also discuss: seven explanations for the reluctance on the part of most hedge fund investors to sue managers; the fund of funds redemption process; how their lawsuits have affected their due diligence process; in-house administration; background checks; the importance of face-to-face meetings; side letters; how Aris investors have reacted to the lawsuits; and Aris’ transition to a managed accounts model from a fund of funds model.
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From Vol. 2 No.36 (Sep. 9, 2009)
In Conducting Background Checks of Hedge Fund Managers, What Specific Categories of Information Should Investors Check, and How Frequently Should Checks be Performed?
Background checks or investigations of managers of hedge funds, private equity funds and venture capital funds are in the spotlight with the recent frauds involving Bernard Madoff in New York and Stanford Financial in Houston. For defrauded investors, the focus in the Madoff and Stanford contexts has shifted to litigation and asset recovery. For those who still are invested in third-party managed funds or are considering investing in such vehicles, the Madoff, Stanford and other scandals have emphasized the importance of investigating the background of the individuals responsible for managing the funds. No background investigation can prevent all fraud. However, background investigations can indicate signs of a checkered past, which in turn can increase the risk profile of a potential investment. In a guest article, Jack McCann and Daniel Weiss, both of investigation firm McCann Global, discuss the specific categories of information that investors should look into when conducting a background check on a hedge fund manager, the frequency with which background checks should be performed (and renewed) and the manner in which background checks should (and should not) be performed.
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