The explosive growth of hedge funds -- not to mention a few exploding hedge funds that burned big-name investors -- has spawned a new growth industry: firms that check up on hedge funds.
"The market runs on fear and greed and we're kind of operating on the fear side. We're trying to alleviate fear for our clients," says Guy Simonian, founder of Cotal Systems.
The West Hartford, Conn., firm specialized in employee background screening until 2000, when a client hired it to investigate 500 hedge funds. That led to the creation of CheckFundManager.com, which has conducted 7,000 hedge fund investigations, Mr. Simonian says.
Hedge funds aren't subject to the same disclosure rules as stocks, bonds and mutual funds, leaving potential investors with unanswered questions about such funds and the people who operate and promote them. While hedge fund investors, including investment managers who assemble portfolios of hedge funds or "funds of funds" for their clients, are more sophisticated than most investors, they lack the expertise required for background checking and would rather focus on analyzing a hedge fund's risk and potential return.
So, to check up on the fund, they hire firms such as Kroll, Intelysis, CheckFundManager, HedgeCheck.com and First Advantage Investigative Services. For fees that range from several hundred to several thousand dollars, they'll get a dossier on the fund and its principals -- including whether their education credentials check out, whether they have the professional licenses and certifications they claim to have, whether they've ever been sanctioned by regulators, sued or bankrupt. Tax liens, messy divorces, arrests for drunken driving and substance abuse problems also are included in the report.
"If it's a public record and we can get our fingers on it, we're searching it," says Kevin Jones, founder of HedgeCheck.com. "It's still astonishing today how many people lie about their education and where they've worked."
The Stevensville, Md., venture is an arm of eDiligence, which performs background checks for clients involved in mergers and acquisitions. Although HedgeCheck is only 2-years-old, it accounts for nearly half of eDiligence's business "just because the hedge fund business grew so quickly," says Mr. Jones.
HedgeCheck charges $750 for a basic search, which Mr. Jones says isn't complete. "But it's a very comprehensive search" for that price, he says. CheckFundManager charges $2,000 or more for an international search on companies or fund managers.
Hedge funds, which are designed to produce positive results no matter how markets perform, got a shot in the arm from the three-year market swoon that began in 2000. They've grown into a $1.1 trillion industry, according to the Hedge Fund Association, an industry group.
The frenetic growth has concerned the Securities and Exchange Commission, which attempted to shed more light on the shadowy funds by implementing registration requirements. The regulations, which were overturned by a federal judge this summer, didn't curb business for firms such as First Advantage, which opened an office in East Liberty last month. Just because a fund was registered with the SEC didn't mean it was squeaky clean, says Ben Schmich, who oversees five investigators at the company's Penn Avenue office. Most of the company's 50 employees are located in Manhattan.
First Advantage Investigative Services is part of First Advantage Corp., a St. Petersburg, Fla., company that also provides consumer credit information to borrowers, investigates insurance fraud, conducts employment background checks and other security-related businesses. The parent company had 2005 revenue of $643.7 million.
Hedge fund investigators do much of their work online, relying on databases that provide corporate, court, property and other records as well as news stories. They also hire contractors who research and retrieve court records and other files that can't be found online. Mr. Schmich says First Advantage also conducts confidential interviews with people who know the subjects being investigated.
But more and more information is only a few clicks away. "Two years ago, there was nothing from the Cayman Islands online. Now, at least there's something," says Mr. Jones.
Depending on how comprehensive a search a client orders, the work can take from a few days to a few weeks. The investigation usually doesn't produce information that prompts investors to walk away from investing in a hedge fund or recommending it to clients.
"Most of the time, the individual checks out, the investment checks out, their credentials check out," says Mr. Simonian.
However, CheckFundManager did alert a client about a 26-year-old fund manager who claimed to have 15 years of experience in the industry, he adds. And after uncovering ongoing disputes involving a separate Canadian fund earlier this year, it steered investors away from that fund, whose assets later were frozen, Mr. Simonian says.
Despite the bad rap the industry got from failed funds such as Bayou Management and Long Term Capital Management, Mr. Schmich says hedge fund managers generally have cleaner backgrounds than another group clients have asked him to investigate: venture capitalists.
"The instance of red flags is 10 percent if not less," he says.
Correction/Clarification: (Published Sept. 12, 2006) This Heard Off the Street column as originally published Sept. 10, 2006 on firms that investigate hedge funds incorrectly stated that First Advantage Investigative Services conducts background checks on venture capitalists. It investigates individuals and companies on behalf of venture capitalists.
First Published: September 10, 2006, 4:00 a.m.