Hedge funds lied to investors

Filed in archive Ethics on October 15, 2009

Hedge funds have been badly exposed in a new study Trust and Delegation . Hedge funds were instrumental in buying bad securities and and helping bring the world's financial system to its knees.

The study found that half the hedge funds (49%) lied and misled investors. "We find that misrepresentation about past legal and regulatory problems is frequent (21%), as is incorrect or unverifiable representations about other topics (28%),'' the researchers say. "Misrepresentation, the failure to use a major auditing firm and the use of internal pricing are significantly related to legal and regulatory problems, indices of operational risk."

The researchers analyzed so-called due diligence reports done for investors in hedge funds. These reports are the only way investors can tell whether hedge funds are sticking to the truth.

The results are staggering.

The researchers write: "The category Noted Verification Problem indicates that 42% of the funds in our sample had either a misrepresentation or an inconsistency problem ... Signature Disagreement indicates that in 16% of the cases, the fund’s version of the signature process did not match the version explained by the administrator, while Pricing Disagreement indicates that 3.6% of the funds disagreed with the administrator on the process used to price the portfolio. Bad Recall indicates that in 21% of the cases, the manager verbally stated incorrect information to the DD (due diligence) company when check against written documentation."

In other words, nearly half misrepresented the truth, or to put it more bluntly, lied and one in five verbally lied.

When you read this, you can then understand how people like Bernard Madoff could get away with their fraud for so many years with his hedge fund. Which raises the obvious question: how many more Madoffs are out there?