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Due Diligence on My Hedge Fund? As a hedge fund manager, expect an inspection potential investors.  You hope that your presentation of yourself and your trading track record will attract investors, but could your efforts be undermined by errors in your former employment or regulatory records?  What would your past paper trail tell someone who does not know you?  There is external information about you and you must make sure that it is correct. Put yourself under review.  Find out how potential investors will see you by performing a "dry run"?  Let us perform due diligence on you and then review the results.   Why not use our professionals to investigate you and your hedge fund before "bad paper" turns investors away?  Contact Us

Due Diligence on My Investors?  As a fund manager, you must "know your clients" (KYC) before you allow them to invest in your fund.  You should know the source of the funds to be invested in your fund and run a detailed background check on a prospective investor. There are well know expensive data bases the allow you to investigate anyone. Some people and entities are blacklisted in certain countries and their "investable money" is considered as tainted. By conducting due diligence checks, you can avoid these investors and their money.  

If you are based in the United States or run a U.S. fund, you should conduct an OFAC check on a prospective investor as well. Why lose sleep at night? Why wait for the FBI or Interpol to come knocking on your door?   We can run those KYC checks for a small fee.  Contact Us for help.

New to Hedge Fund Management?
As a new hedge fund, you may not have yet experienced a due diligence review.  Understandably, you may feel daunted by the comprehensive nature of the due diligence process.  By hiring qualified professionals, you can get a good look at what due diligence would produce on your background.  Our third-party, objective due-diligence services, coupled with our industry-leading legal services, can help you get some perspective on your overall appeal as a hedge fund manager.

The Meaning of Due Diligence Due Diligence refers to a comprehensive investigation and/or audit of a potential investment that serves to confirm, as much as possible, all material facts in regard to a purchase or sale.  Generally, due diligence refers to the care a reasonable person should take to obtain all the material facts before entering into an agreement or transaction with another party.  Due diligence provides an investor some security in an otherwise risky environment.  You can do little to control market forces, politics, regional instability, and global economic conditions when you invest.  However, there is something you can do to keep from being a victim of deception: check the qualifications and background of a hedge fund manager before giving him your money. Fraud is often the reason a hedge fund goes under.  As history shows, investors have all often entrusted their money to hedge fund managers who are irresponsible or even criminal.  Before explaining how due diligence can reduce the risk of fraud, let's revisit a few common scenarios.

Hedge Fund Manager Covers up Losses In this situation, suppose that the hedge fund manager has a clean record.  He is reputable and has set up the fund to industry standards, with all the appropriate documentation and disclosures. He accepts client funds and begins investing the capital responsibly, according to his duties. However, an over-leveraged trade or overly concentrated investment goes south. The hedge fund manager fears that if he dutifully reports such losses his investors will leave.  So he devises a plan to earn the money back with future trades. Until such returns are realized, he will produce false financial statements.  Of course, he has to use a higher leverage ratio because of the lower investment balance, and the trades are highly risky. They too, perform poorly.  But because of the forged statements, you as an investor feel satisfied. Naturally, one would assume that a legitimate request for a withdrawal of funds would expose the cash-strapped operation. Not necessarily.  Due to a false positive performance record, the hedge fund manager attracts new investors, and simply pays a withdrawal request with new investors' money. Will you be holding the bag when the operation falls?

Hedge Fund Manager Supports Lavish Lifestyle with Investors' Money In this situation, a hedge fund manager with a shady financial past sets up a hedge fund based on a "stellar career" in the investing world.  He sets up the fund according to industry standards and convinces investors that he can generate excellent returns.  He never invests the funds, and instead he withdraws money for personal use, living a lavish lifestyle.  Statements are faked to show positive earnings. The manager promises a strictly monitored and audited operation. However, the audits are never done or are done under an unknown auditor's name.  Worse yet, the investors never ask for audited financials. Eventually, the fund is exposed. Hindsight reveals the shady past of the manager--the securities violations, bankruptcy, and open judgments.  It turns out that the "stellar career" never existed as he simply worked entry-level positions and was fired. This is all easily revealed during the investigation and legal process that follows.  Could you have avoided this?  Need help? Contact Us

Hedge Fund Loses Large Percentage of Capital; Closes Operations In this final scenario, everything is handled in a generally legitimate manner.  Statements are accurate and sent out in a timely fashion.  he only problem is that they paint a gloomy picture. Investors receive informal promises and indications that the market is looking good, or that the strategy is expected to pan out.  Instead, more money is lost, investors lose confidence and withdraw, and the fund closes operations. Most of your money has disappeared, and you have little or no legal recourse. You relied upon a colleague's advice as well as the fact that a well-known investor had a position in the fund. You had confidence in the manager from what you had heard, but later find out that the manager had little to prove that he could invest wisely. You learn, too late, that a significant percentage of all executives misrepresent accomplishments on their resumes. Often they omit various positions (as opposed to embellishing them). Sometimes they include a degree from an unaccredited on-line school. Could this have been found out before investing?

Investment Manager Is the investment manager registered as an investment adviser with SEC? If yes, review Form ADV. Review entire form and, in particular, look for number of personnel employed, number of clients, and funds under management.  Also, look for whether any advisee clients are SEC registered investment companies or non registered funds, and whether the adviser has had problems with regulators, has other business activities, etc. Does the investment manager have conflicts of interest with the fund and does the manager have any controls in place to manage those conflicts?  Is the investment manager registered with any state regulatory authority as an investment adviser? If so, review forms. If not registered as investment adviser with SEC, or state level, higher level of scrutiny required. Examine the investment manager's Articles of Organization and Certificates of Formation, jurisdiction of organization, location of office, and EIN letter from the IRS. Note that it is very rare for the investment manager of an onshore fund to be organized in a foreign jurisdiction.
\What licenses do individuals employed with the investment manager possess?  Many management personnel possess a securities license, such as Series 7 (registered representative of a broker-dealer) because the manager is itself registered with the SEC as a broker-dealer.  If individuals are investment advisers, they will be required to have the Series 65 or equivalent.  What are the educational and professional credentials of the personnel?  Verify credentials listed. What institutions of higher learning did they attend? Do they have a graduate degree in business or economics; sometimes, engineering, mathematics, medicine?  Are they a CFA (Certified Financial Analyst) (the standard industry credential for professional investment managers?).  What are the employment histories of the personnel?  Were they employed at other hedge funds?  If so, verify employment and review the history of those funds. Were they employed at major financial institutions, and, if so, in what capacity? Examine the investment manager's past performance. Obtain photo identification from the manager (driver's license, passport, etc.).  Perform background checks on the manager and the principals of the manager.  Useful places to look are Dun & Bradstreet report (credit check) and KnowX.com (background check with information on bankruptcies, liens, lawsuits, judgments, and UCC's).  Be sure to obtain permission from each individual to run a background check. Check on court decisions against the manager and its principals.  Get state and federal filings on the manager.  Do a search on FACTIVA (Dow Jones news retrieval service) or similar service to obtain media articles about the manager and its principals. Get at least three references from the manager: inquire as to who the references are and conduct further due diligence.

Hedge Fund Due Diligence Is there a way to sniff out fraud before it is too late?  The problem is that those who are good at deception know how to appear honest.  Fortunately, there is a way to discover fraud.  With expertise and access to records and information, you can uncover the past of a hedge fund manager.  You can employ a background check firm, a private investigator, or perform your own record checks online. These tools may reveal information on the background of the hedge fund manager.  But is that enough?  Even honest hedge fund managers fail.  And the signs of failure are often clear in advance.  But these signs may not be clear to a general background check firm, to a private investigator, or to anyone who is not an expert on hedge funds.

This is where we come in. We are a well-known industry leader in the areas of hedge fund development, compliance, operations, and tax.  We know how a hedge fund should be set up.  We know who should be registered and with what authority.  We know what hedge fund managers can and cannot do?and what they should be doing.  To put it plainly, we are fully equipped and knowledgeable in every aspect of a hedge fund operation.  We can provide you with a complete due diligence package that goes well beyond a simple background check.  We know what to look for and can help you avoid large losses.  We can help before you invest, or after.  We know how to uncover inconsistencies that are signs of trouble. Hedge funds that turn into frauds cannot bear the scrutiny of our due diligence process.  Your investment is too valuable to see it squandered by unsavory individuals. Due diligence is a small price to pay to avoid the substantial loss and suffering that can result from fraud. A little due diligence goes a long way.  Contact Hedge Fund Attorney Hannah Terhune for Assistance

Organizational Issues What is the fund's mailing address? Physical address? If there are multiple addresses for the fund or if the fund shares an address or office space with another fund or another  business or company, require an explanation and obtain document (written contract) that enables sharing.

Is the fund registered with the SEC? The state? Request a copy of Form D, as filed with SEC and relevant states.  Verify the Form D or state regulatory equivalent filings in all states.

Is the fund domestic or offshore? If offshore, determine whether the manager and/or fund are subject to local regulatory oversight and, if so, obtain regulatory filings.  Ask about the prime broker or other custodian(s), and administrator(s).

In what state is the fund organized? Most domestic funds are organized in Delaware, although some are organized in Nevada, and, occasionally, in another state.

What is the form of organization? Domestic funds are typically organized either as a limited partnership (in which the manager is the general partner and the investors are limited partners) or as a limited liability company in which the manager is the managing member and the investors are non-managing members). Obtain fund formation documents (e.g., Articles of Organization or Articles of Association).  Request a State Certificate of Good Standing from the fund. This may also be obtained from the state of formation.  Contact the state to verify the certificate’s status, and request that the certificate be mailed directly to you.

Is the fund reputable? Find out where the funds and securities are kept. If not New York, London, or some  other major financial center, this may be a warning sign. Inquire about the lawyers and  the accountants; there is a limited universe of professionals in each offshore jurisdiction,  and use of professionals who are not well-known raises concerns.

Operational Concerns What are the terms of the Fund; performance fees, withdrawal restrictions? Does the manager have the right to more than 20% of the profits regardless of  performance?  If so, think twice about investing. Does the manager's right to profits  require that it first exceed a stated return to the investors (termed a hurdle rate)?  If not,  think twice about investing.

Does the agreement have a high water mark? If not, it is probably inadvisable to invest since this may indicate unfairness on the part of the manager.

Fund of Funds Is it a fund of funds? If so, there are special considerations; the most important of which concerns fees and compensation to the two levels of managers. Obtain a copy of the Investment Advisory Agreement between the fund and the  investment adviser. Verify that it conforms to the stated purpose in the fund's Offering  Memorandum.

Does the agreement permit an investor to withdraw all or part of its capital? If so, on  what conditions must the investor give written notice (such as 90 days or 180 days), and  how often in each year can an investor withdraw? Industry standards vary. In some  cases, withdrawal four times a year is permitted, in other cases, only on December 31, after giving notice 90 days in advance. If the agreement contains very restrictive  withdrawal rights, think twice about investing.

Does the fund have an Engagement Letter with an attorney on file? Obtain a copy and  contact the attorney to verify the client relationship.

Does the fund have an Engagement Letter with an auditor on file? Obtain a copy and  verify the client relationship.  Obtain copies of the last three years audited financial statements directly from the  auditor. Do not accept copies provided by fund.  Review them to see whether they agree  with what the manager has represented to be the fund's results.  Obtain copies of filed tax returns for last two years directly from the fund's accounting firm.  Do not accept summaries provided by the fund. Tax returns should include schedules and statements (except Schedule K-1, which discloses each investor's position in the fund). Compare results to audited financials, and reconcile tax results with financials (through unrealized gain/loss). Determine whether for tax purposes the fund is treated as a trader in securities (favorable treatment) or as an investor (unfavorable treatment). If the fund is a fund of funds, does the manager issue its financials and timely tax returns,  or are there extensions?

What are the strategies employed by each of the sub-managers in the investee funds, and are they sufficiently diversified to spread risk?  Obtain performance reports for the past 5 years. If the PPM gives statistical history,; review this and compare to audited financials.  If the manager provides historical results; ask if the results follow AIMR (industry association) guidelines.

Does the fund report far superior results to other funds in its investment strategy group?  If so, ask for an explanation since there have been a number of frauds involving  purportedly excellent results that ran counter to prevailing trends; Review the fund's Offering Memorandum. If there is a Form ADV (there will be if the  manager is a registered investment adviser), compare the Form ADV to the PPM and to the one on the FINRA website.

Who are the prime brokers or other custodians for the fund? It is common for a hedge fund to have one or more prime brokers, who track the investments and custody the funds; Use of a prime broker is a positive indication; However, if the fund invests in commodities, that part of the investing cannot be done through a prime broker; Also, very large funds ($500 million and up) do not use a prime broker because it is not cost effective.

Call Us First  We are experts in international hedge funds and tax. Click on any reference below to our leading articles:

Strategic Hedge Fund Planning by Hannah Terhune.  Wilmott Magazine Ltd. (Volume 2013, Issue 63, pages 8-11 January 2013).

Hedge Funds - Limited Partners' Right of Access After Parkcentral Global, L.P., v. Brown Investment Management, L.P. by Jim Brennan.   Cititrust Edge Magazine (4th Quarter 2012).

Strategic Hedge Fund Planningby Hannah Terhune.  Canadian Hedgewatch (March 2012).

Strategic Hedge Fund Planning by Hannah Terhune.  MoneyScience (March 2012)

Hedge Funds - Limited Partners' Right of Access After Parkcentral Global, L.P., v. Brown Investment Management, L.P. by Jim Brennan.  Canadian Hedgewatch (July 2011).

Planning for Cross-Border Financing Arrangements.  Practical International Tax Strategies (May 31, 2011).

U.S.--Tax Traps of Non-U.S. Issuer Debt Offerings.  Practical International Tax Strategies (April 15, 2011).

America the Beautiful Tax Haven.  Cititrust Edge Magazine (1st Quarter 2011).

Offshore Hedge Fund Focus:  Master & Feeder.  Cititrust Edge Magazine (4th Quarter 2010).

U.S.--Cross Border Credit Agreements:  Planning for U.S. Withholding Taxes.  Practical International Tax Strategies (November 15, 2010).

Starting an Offshore Fund.  themanager.org (June 2008).

Mixing Investment Adviser and Brokerage Services.  Hedge Fund Monthly by EurekaHedge.com (October 2007).

Offshore Fund Taxation.  Hedge Fund Monthly by EurekaHedge.com (May 2007).

Forex Trader to Forex Manager.  Offshore Business Magazine (November 2006).

Forex Trader to Forex Fund Manager:  The Path to Success.  Hedge Fund Monthly by EurekaHedge.com (October 2006).

Drafting Hedge Fund Performance Allocations.  Hedge Fund Monthly by EurekaHedge.com (August 2006).

Como Crear su Propio Hedge Fund by Hannah M. Terhune, Eva Porras, Argilio Rodriguez and Garrett Fisher (2006).

Offshore Hedge Funds: Focus on Master/Feeders by Hannah M. Terhune (2006).

Temas Sobre Impuestos de Sociedades Colectivas para Hedge Funds en Paraiso Fiscal by Hannah M. Terhune (2006).

Establish a Marketable Track Record with an Incubator Fund by Hannah M. Terhune (2006).

Must I Register as a Commodity Pool Operator? by Hannah M. Terhune (2006).

Do’s and Don’ts for Crafting Hedge Fund Peformance Allocations by Roger D. Lorence and Hannah M. Terhune. Derivatives:
Financial Products Report (an RIA publication) (September 2005).

Trading Foreign Index Contracts? Know the Tax Rules Before You Trade by Hannah M. Terhune and Roger D. Lorence. Stocks, Futures and Options (June 2005).

Practical Strategies For Section 475(f) Elections by Roger D. Lorence and Hannah M. Terhune. Derivatives Financial Products Report (WG&L/RIA,a Thompson Company) (March 2005).

Forex Hedge Fund Management by Hannah Terhune and Roger D. Lorence.  Currency Trader (March 2005).

Advising Clients on Internet Server Co-Location Agreements, Practical International Tax Strategies (March 15, 2004).

Structuring and Financing International Operations Using Hybrid Entities and Tax-Efficient Financing Practical U.S./International Tax Strategies (Jan. 15, 2004).

Hedge Fund Compensation Arrangements. Practical U.S./Domestic Tax Strategies at Page 18 (Dec. 2003).

U.S. Inbound Investment – The Portfolio Interest Exemption. Practical U.S./International Tax Strategies (Dec. 15, 2003).

Foreign Futures Planning: The 60/40 Question. Practical U.S./International Tax Strategies at Page 12 (Sept. 30, 2003).

Managing Offshore Hedge Funds - A View from the Beach: Practical U.S./International Tax Strategies at Page 9 (June 15, 2003).

Offshore Hedge Funds - Master/Feeder Compliance Issues: Practical U.S./International Tax Strategies at Page 9 (May 15, 2003).

Ready for Help? Please call us (307) 213-4732 or e-mail Hannah Terhune, international hedge fund and tax attorney.

Capital Management Services Group, Inc. is an authority in the hedge fund industry. It is a forward thinking law firm focused on creating long-term collaborative relationships with a select group of clients interested in the same.  It strives to provide “high touch” service and perform a defined set of legal and other services with impeccable efficiency.  Our best ideas are not on this website. When you consult with us, you have access to a unique and desirable blend of professional experience. Give us the opportunity to put our knowledge and expertise to work for you. We provide high quality services at competitive rates. We offer “white glove” corporate concierge service to select clients.  Need to develop a tax and regulatory footprint outside of your home country? Give us a call and let us prove what we can do for you.  We offer virtual residence and virtual office services in Delaware, Florida and in other locations. We can assist with opening U.S. bank and brokerage accounts. We have many ideas and the resources to implement them. Get answers to your specific questions and purchase a consultation with a lawyer.  We look forward to connecting with you personally and are confident that you will be impressed. We set up a variety of investment funds, provide business and global tax advice, while offering continuous support services to our clients.  We help our clients as their needs evolve and take pride in maintaining relationships with our clients. The views expressed on this website are subject to change based upon new information, new technology, consideration of new perspectives and/or for no reason at all. This website exists for educational purposes and nothing on this website should be considered as legal advice.  Website content and design are copyrighted 2023© by Hannah M. Terhune and all rights are reserved.