Lessons learned from hedge fund frauds and blow-ups: the 10 key questions for hedge fund due diligence

Algorithmics' Algo FIRST database now recording more than one hedge fund fraud every day

Toronto, London, New York - July 27, 2009 -

From an analysis of approximately 400 reported hedge fund frauds and blow-ups, Algorithmics has devised the ten most important questions for anyone with investment or business exposure to a hedge fund. Algorithmics tracks these events in its Algo FIRST database, which is currently registering more than one report of a new hedge fund fraud case every day.

Penny Cagan, Managing Director and Head of Content Group, Algorithmics, said: "The size and breadth of recently reported hedge fund fraud events illustrates the imperative necessity of undertaking proper due diligence and of framing the right questions when analyzing vehicles for investment funds. Service providers to the Madoff feeder funds, such as custodians, are becoming targets of lawsuits by investors who are seeking to be made whole. This means that due diligence is equally important for not just investors, but also custodians, prime brokers, and fund administrators."

When asked if recent activity equates to a large increase in recent reports of hedge fund fraud events, Penny Cagan added that, "on the contrary, many of these events have been ongoing for years and in some cases, decades. They are being discovered now as a result of the turmoil in the financial markets and the associated increase in redemption requests. Fraudsters cannot hide their misdeeds when investors want their money back."

The following provides a sampling of just ten of the most important questions that should be asked by anyone who has investment exposure to a hedge fund; a list of twenty-two key questions have been developed from the hedge fund frauds and blow-ups in the Algo FIRST database:

  1. What is the experience level of senior traders and management?
  2. What is the quality of stress testing and risk scenarios and do they include the interplay of different types of risk and market events? Do the stress tests account for an unraveling of different types of securities by major market players at the same time?
  3. Has investment drift occurred? Do actual investment strategies match what is reported in fund prospectuses?
  4. What is the operational risk culture within a fund and does a star culture exist? Who are the stars? Are traders that push the boundaries tolerated or heralded?
  5. Is there a concentration in certain securities or strategies and is overconcentration in a certain position present?
  6. What is the quality of the fund's market practices and is there a potential for conflict of interest and fiduciary breaches?
  7. What exchanges does the hedge fund trade on and are they regulated or unregulated exchanges?
  8. Are the staffing levels appropriate to support the infrastructure of the fund? Do they keep abreast of growth in assets?
  9. Has there been a dramatic change in assets under management and/or level of redemptions during the past year?
  10. What is the quality of back office operations and support and trade processing, execution, confirmation, and the percentage of failed trades?

Hedge fund blow-ups comprise a sub-section of 8,500 carefully researched and analyzed case studies in the Algo FIRST database. Algorithmics' in-depth, research-oriented and targeted approach to analyzing risk events is currently utilized by approximately 100 financial institutions across the globe in their self assessment, risk assessment, scenario, and risk awareness programs. The case studies are structured in a way that allows hedge fund professionals and risk managers to ask the pertinent questions when they analyze vehicles for investor funds.

For an overview of Algorithmics' risk management solutions, please see: http://www.algorithmics.com/EN/solutions/overview.cfm

For further information please contact:
Heather Smith
Senior Communications Manager, Algorithmics (UK) Ltd
Direct line +44 (0) 20 7392 5820
Mobile +44 (0) 7515 974223
E-mail Heather.smith@algorithmics.com  

Notes to Editors:

For the full list of 22 due diligence questions and a copy of the Algo FIRST Madoff case study, please contact Heather Smith as above.

Algorithmics is the world's leading provider of risk solutions. Financial organizations from around the world use Algorithmics' software, analytics and advisory services to help them make risk-aware business decisions, maximize shareholder value, and meet regulatory requirements. Supported by a global team of risk experts based in all major financial centers, Algorithmics offers proven, award-winning solutions for market, credit and operational risk, as well as collateral and capital management. Algorithmics is a member of the Fitch Group. www.algorithmics.com

The Algo FIRST database is a uniquely designed research tool that helps financial institutions understand, identify, and manage operational risk. Recognized by analysts and practitioners alike for its industry-leading coverage, the ever-expanding Algo FIRST database contains thousands of real-life case studies on external risk loss events. Algo FIRST highlights operational risk, corporate governance, strategic, liquidity, and market events, control breakdowns, and management responses to help organizations prevent losses before they occur. Subscribers can proactively apply lessons learned from over 8,000 real-life case studies to help minimize their risk exposure and enhance internal controls. Algo FIRST is constantly expanding. www.algorithmics.com/EN/services/23-prodserv.cfm

Fitch Group is the parent company of Fitch Ratings, a global ratings agency committed to providing the world's markets with independent, timely and prospective credit opinions. With 49 offices worldwide, Fitch Ratings' global expertise spans across capital markets in over 150 countries. Fitch Ratings is headquartered in New York and London.

The Fitch Group also includes Fitch Solutions, a distribution channel for Fitch Ratings products and a provider of data, analytics and related services; and Algorithmics, the world's leading provider of enterprise risk solutions.

The Fitch Group is a majority-owned subsidiary of Fimalac, S.A., headquartered in Paris, France. For additional information, please visit www.fitchratings.com www.algorithmics.com and www.fimalac.com  

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