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The financial crisis has already put pressure on hedge funds to open up their opaque operations.
Now there’s a damning report to help the case for more transparency: many of them are lying.
Research from the NYU Stern School of Business based on confidential due-diligence reports shows that managers often lie about the amount of money in their funds, how well they performed, and regulatory and legal histories.
Here’s the abstract:
SSRN via FT: Due to imperfect transparency and costly auditing, trust is an essential component of financial intermediation. In this paper we study a comprehensive sample of due diligence reports from a major hedge fund due diligence firm. A routine feature of due diligence is an assessment of integrity. We find that misrepresentation about past legal and regulatory problems is frequent (21%), as is incorrect or unverifiable representations about other topics (28%).
In the paper itself (below, page 11), we find what the “other topics” means, and it ain’t pretty:
Surprisingly, nearly 19% of funds’ asset information either could not be verified independently (Assets Disagree) or the [Due Diligence] firm found a disagreement between the fund’s reported assets and evidence from an alternative source (Can’t Verify Assets). Similar discrepancies (Performance Disagree) or verification problems (Can’t Verify Performance) with respect to reported performance were noted for 14% of DD investigations. The DD firm also found that 20% of managers (Bad Recall) interviewed had poor recollection about basic levels of assets and performance. For example, one manager’s verbal assets under management figure were over $300 million higher than the actual number.
This should give those who want improved regulation of hedge funds a big boost. Or, at the very least, push more hedge funds to disclose assets in verifiable ways. And if you’re thinking of starting your own hedge fund, take note: the report says the firms that lied essentially did no better than firms that kept it honest.
Here’s the full working paper: