| Randy Shain, BackTrack Reports |
Randy Shain is a private investigator of sorts, but his 21-year-old-firm, BackTrack Reports, in New York, specializes in investigating the people who work for hedge funds. Shain, 48, says his team would have easily found out that Mathew Martoma, the former SAC Capital Advisors fund manager convicted of insider trading, applied for the job with a falsified Harvard Law School transcript. BackTrack’s due diligence is aimed at uncovering character flaws and misleading statements. Hedge fund executives can hire BackTrack Reports to check the background of potential employees, while hedge fund investors can hire the firm to check out the character of the people who are going to be managing their money. Shain spoke with Alpha about why investors who put a microscope to the performance record of a hedge fund should conduct the same kind of due diligence on the people behind it. Q. How did you become the Sherlock Holmes of hedge funds?
A. Growing up, I had an uncle who was an investigator for the Newark Department of Labor, and he was quite a storyteller. The work always sounded exciting, but I sort of forgot about it in my teens. I went to Rutgers University and took a class in criminal justice, but I majored in marketing. Then, after I graduated, I read the book What Color Is Your Parachute?, and everything in it pointed me toward being an investigator. I started smiling-and-dialing every investigative agency in New York and New Jersey until I found one willing to hire me. I worked there, at Bishop Services, for six years until a colleague and I left in 1993 to start BackTrack. At the beginning, our focus was on background reports prior to big business transactions. But fast-forward to 2000, and a lot of those deals dried up. We started getting some clients who ran funds of funds, and we saw that more and more hedge funds were being formed.
Q. So was it fund-of-funds managers who drove the demand for your research on hedge fund managers?
A. Fund-of-funds managers and consultants were quick to do this. I do think the fund-of-funds industry doesn’t get its proper due. All you read is that they add an extra layer of fees. The reality is, sure, pension fund managers are now coming to hedge funds directly, but those that can are building a staff to investigate hedge funds. In effect, they have to mimic what fund-of-funds managers have done, which includes the kind of background checks that we do. And it’s very important, especially for smaller pension funds. The $500 million pension fund that services the police and firefighters in a small town is more likely to be the target of a fraudulent hedge fund manager than a big pension fund or fund of funds is. I feel very strongly that in this industry investors should make sure they’re making the best decisions. The money in pension funds ultimately belongs to the everyday Joes, and if a fund goes bust, ordinary taxpayers pay for it.
Q. What kinds of red flags do you raise for investors?
A. There is a strong correlation between fund managers who’ve had public blowups and those who said something that wasn’t true in their biographies. Saying you have a BS in finance when it’s actually in accounting isn’t so bad, but it’s more significant if your degree was actually in sociology — or if you were in college for just one semester, which was the story with Tom Petters, who was convicted in 2009 of running the third-largest hedge fund fraud case in U.S. history. Sam Israel, who was convicted of running a Ponzi scheme through Bayou [Hedge Fund Group], gave out a bio to investors that said he’d been a general partner and head trader at Omega Advisors, which turned out not to be true. If you’re willing to boost your accomplishments to get investors’ money from the beginning, you’re more likely to be the type of person who would lie to keep the money.
We go through public records to verify work and educational history, then court records. The courts are where there is a big difference in the quality of research. In many courts you have to search the records manually. But even with information that’s available by computer, one mistake people sometimes make is the assumption that every search will be like using the bat computer: Batman punches one button, and the computer shows him where the Riddler is. But before 2008 you could have put in the name “Bernie Madoff” along with the key word “fraud” and turned up nothing, whereas if you’d done a true contextual search, you would have found a number of news articles that made a case for his funds not looking right.
Q. Frauds happen but not every day. Do you also look for subtler problems that might point to risks?
A. Yes. One of the big risks is whether a fund manager is actually good at managing a business. We investigate that by interviewing former colleagues, trying to find out what people think of this person and his or her abilities. Most of the time we’ll find that the manager is very good at what he does with some weaknesses. But suppose five people all say this guy is as honest as the day is long, a fantastic trader, knows how to manage his people, but he’s not a good marketer. An investor might well ask, “Then how come he’s the guy who’s marketing the hedge fund?” You might have a skillful, ethical manager, but there is a big business risk if he doesn’t know how to sell the fund and hasn’t acknowledged it and hired someone else to do the marketing.
Q. Your background checking could, presumably, uncover a prospective employee with a problem record.
A. Checking new employees is a big line of business for us. I hate to malign Mathew Martoma, but the news about his forged transcript has hedge fund managers realizing that it behooves them to check out the people they hire thoroughly. Those searches are usually a little easier than investigating hedge fund managers, because the people we’re investigating are generally younger, so their records are shorter.
Q. Your staff investigators have backgrounds as journalists rather than as private detectives. Why is that?
A. Journalists know how to get someone on the phone they don’t know, who isn’t expecting their call, and get them to talk, even though the source won’t get anything out of the conversation. And even more valuable, journalists can take thousands of pages of information and pull it all together into a cogent narrative. If there’s a six-month gap in a fund manager’s résumé and an old press release announcing a position he started during those six months, we’ll produce a narrative that explains where there’s a discrepancy and what we’ve discovered. We’re going to take all of the data and make it readable.
