Hedge Fund Investing: A Practical Approach to Understanding Investor Motivation, Manager Profits, and Fund Performance

Fraud Risk

Investors in hedge funds always need to be on the lookout for fraud. Despite the due diligence done on the investment, risk management, and operational practices of a manager or fund, and even where there is a complete understanding of the business model risk, investors can still find themselves defrauded.

The FBI lists hedge fund fraud as a type of white-collar crime on its website. It says that hedge funds are minimally regulated investments that present many risks to investors. It says that hedge funds can and do fail for many reasons, including leverage or increased risk taking due to negative cash flows to the management company following periods of withdrawals. It says that fraud is another risk present when investing in hedge funds, and it goes on to elaborate on several types of frauds that might occur.

According to the FBI website, there are several potential indicators of fraud that investors should investigate before investing in a fund.

Lack of trading independence when a fund executes via an affiliated broker-dealer.

Investor complaints about lack of liquidity.

Litigation in civil court alleging fraudulent acts.

Unusually strong performance claims.