Hedge fund administrator ignores red flags of Ponzi scheme

    chart magnify glassThis case involves an alleged Ponzi scheme at a hedge fund in which approximately 30 investors lost between $250,000 and $300,000 each, for total losses of about $10 million. The fund’s investment manager chose to invest in unknown companies, rather than the blue chip stocks they had initially invested in. The fund administrator was instructed to send the values of these positions to investors on a regular basis, as determined by the investment manager. The hedge fund administrator never received those valuations from the investment manager. At the time, investors believed that the fund administrator was performing proper due diligence, vetting the positions they were invested in, but they received little to no response from the investment manager. The fund administrator also knew that the investment manager had not obtained an audit for 3 years.

    The plaintiff alleges that the defendant failed to verify the existence of the hedge fund’s holdings, ignored a multitude of red flags and inconsistencies in the fund’s accounting practices and even manipulated the fund’s accounting in order to support an inflated net asset value calculation and communicated this false information to the fund investors. Ultimately, the fund collapsed, the investors lost all of their investments and the hedge fund manager pleaded guilty to criminal fraud. The plaintiff believes the hedge fund administrator had more responsibility in ensuring their investments were legal, safe and transparent.

    Question(s) For Expert Witness

    • 1. Can you discuss your experience in hedge fund administration?
    • 2. What are the duties of the administrator when it comes to safeguarding investors from fraud?

    Expert Witness Response E-007935

    I have spent more than 20 years conducting investment and operational due diligence on alternative investment managers, specifically hedge funds, fund of hedge fund and 40-Act alternative mutual funds. The business process management I follow places a strong emphasis on the assessment of operational risk factors, including the independent verification and communication with outside service providers, including the administrator. Most institutional investors and consultants seek a top-tier administrator to provide credibility to the fund under review. The role of the administrator has morphed over time, but the general functions are fund accounting, including independent portfolio pricing, which typically includes everything from trade capture to calculation of NAV. The administrator will also conduct profit and loss calculations, as well as fee calculations and partnership accounting. There are also other shareholder and corporate services an administrator may be engaged to undertake, depending on the needs of the client. It is precisely this independence that is so critical to outside investors. In the course of my due diligence review, I will contact the administrator for screening. These responses are a critical component of any thorough due diligence process.

    This expert has nearly 22 years’ experience in the financial services industry, with a focus on direct investment and operational due diligence of alternative investments. The experthas a B.S. in Finance and Accounting, and focuses on in-depth inspection of hedge funds and their operations including hedge fund administrators. At a major asset management firm, this expert served on the national due diligence unit and was responsible for the monitoring of hedge fund, fund of hedge fund, and liquid alternative investments in the U.S. and Asia. The expert currently serves as President and CEO of an alternative investment consulting firm that, among other things, focuses on thorough investment and operational due diligence and insurace risk assessment.

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