The Millennium Management LLC scandal over late trading and market timing in mutual funds proves that some hedge funds of funds' due diligence in picking individual hedge funds is poor.
Steven B. Markovitz, a senior trader at the $1 billion hedge fund Millennium Partners LP, New York, pleaded guilty in New York Supreme Court on Oct. 2 to charges of improper trading in mutual fund shares. The suit was brought by New York Attorney General Eliot Spitzer.
The due diligence issue is important to institutional investors because all but a few of the largest are likely to invest in funds of funds, rather than in individual hedge funds. Many of them could have had some exposure to Millennium.
"This issue of mutual fund market timing is the perfect example of what fund-of-funds companies should have known about Millennium Partners. It creates the kind of headline risk that fund-of-funds companies have to explain to clients, especially if they stay in it," said Alan Dorsey, head of hedge fund research and investment at CRA RogersCasey LLC, Darien, Conn.
Added Michael Rosen, principal at Angeles Investment Advisers LLC, Santa Monica, Calif.: "Funds of funds receive a substantial fee to conduct due diligence. If a hedge fund manager wants to commit fraud, it may be very hard to detect it. But the one thing that all this has taught me is to wonder how deep the due diligence of hedge fund-of-funds companies really goes. Are they really doing it? Or just ticking off items on a checklist? It's one thing to ask the question: ‘Do you do mutual fund market timing?' And it's another to go and look at a hedge fund's trading record to verify what they do."