In Focus

November 15, 2005

edge fund due diligence. Investors pay third-party advisers and hedge fund managers to perform it. Are they?

One has some doubts, witnessing the recent large debacles among hedge funds such as Bayou Group, KL Financial, and Wood River Capital Management. Each hedge fund displayed "Red Flags" that the investors' trusted hedge fund gatekeepers either overlooked or minimized. No doubt, the third-party gatekeepers may be liable to their clients for their hedge fund losses arising from the gatekeepers' failing to conduct adequate, ongoing due diligence and monitoring.

Further, investors must be wary of possible conflicts of interest. For example, some of these gatekeepers are paid twice. Gatekeepers are paid not only by their clients but sometimes also by the hedge funds, which pay a (disclosed?) finder's fee / referral fee. That's the case with a Canadian hedge fund, Portus Alternative Asset Management. According to Investment News, about 1,000 advisers steered some 26,000 clients to Portus in exchange for a 5% referral fee. This $800 million fund was closed and forced into receivership.

Investors are entitled to high quality hedge fund due diligence, without conflicts of interest. Anything less is a breach of trust that the clients of the gatekeepers should not tolerate!

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James J. Eccleston is a securities attorney, representing customers as well as brokers and brokerage firms nationwide in arbitration, litigation and regulatory matters. He maintains an informative website at www.FinancialCounsel.com. He is an equity partner with Shaheen, Novoselsky, Staat, Filipowski & Eccleston, and can be reached at 312-621-4400.