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Opalesque Futures Intelligence

Futures Lab: How good is a background check? A veteran investigator discusses the key considerations.

Wednesday, November 04, 2009

Checking Out Background Checks

After Bernard Madoff and assorted scandals, many investors look to background checks on traders and managers for early warning signs of trouble. But how do you know that a background investigator is doing a good job? What questions should you ask the investigator? Here are key considerations for checking whether the investigation is careful and thorough.

Our source is David Fisher, who heads the AlphaMetrix financial investigations unit. He worked for the US Secret Service for 24 years, at offices in Washington, Miami and Chicago. He retired from the federal government in 2008.

See the next section for more on AlphaMetrix, a managed account platform for commodity trading advisors and managers in other strategies.

The aim of a background investigation is to prevent bad outcomes. In a way, background checks are similar to what the US Secret Service does, trying to prevent bad things from happening, as opposed to investigating what has already occurred. A good background investigation is extremely valuable to the client who requested the check. If investigators do their job well, dangerous situations are averted.

Here are the basic steps in any background check process:

  • The subject completes consent and release forms;
  • The information provided is independently verified;
  • All available public records pertaining to the subject are reviewed;
  • Information not provided by the subject is sought;
  • A thorough and accurate written report is prepared for the client;
  • Issues and concerns raised by the client upon review of the report are addressed.

In this industry the subject is usually a manager or trader, but some managers have been known to turn the table and ask for background checks on would-be investors.

A big part of a background check is to verify the information provided by the subject. The investigator looks for inconsistencies and gaps. If there is something the manager did not tell you, it may be significant. Suppose there are a couple of years unaccounted for, with no address given for that period. Well, that could indicate a period of time about which the manager is uneasy, perhaps for ethical or criminal reasons.

It is up to the client – usually a potential investor – to decide how to use a background report. Not everyone will think that some discrepancy about a manager's high school record from 20 years ago matters. But embellishing one's educational record, common though it is, suggests a lack of integrity. That could mean trouble down the road.

As the client, you should get a clear answer when you ask about any part of the process and report. A good investigator will systematically go through the above steps and observe the following rules.

  1. Look Beyond Databases.

    Information from commercial databases is typically the beginning of an investigation rather than its end point. For instance, a database search might verify everything a manager has stated, but also find an address the manager did not mention.

    While the manager may have simply forgotten to list a past address, it is also possible he did not include it because while living there he had a legal problem. Once the address is known, the appropriate court records can be searched to see if there was something more than forgetfulness behind its exclusion from submitted information. In fact, a review of the court records of all the counties where someone lived is necessary.

    Database records can indicate a direction to explore, but they are often insufficient or misleading. For example, records are frequently inaccurate and out of date and common names are difficult to authenticate.

    Further, due to the international scope of the hedge fund industry and its complex web of legal and regulatory codes, language barriers and local customs, background investigations often require “boots on the ground.” Because personal inquiries may be the only way to obtain accurate and useful details, the use of a global investigations network is what differentiates a true financial investigation from the standard background check.


  2. Conduct “Out of Sample” Queries and Verifications.

    The investigator needs to develop additional personal references beyond those provided by the subject. Often a subject will give his best friends as references, stacking the deck in his favor. I put little credence in listed references. It is best to put less emphasis on what they say about him, but to talk with them and try to find out who else might know him.

    Similarly, while talking to former employers the investigator should try to determine if the interviewee is aware of the subject's other previous employers. These days employment verification is almost automatic and employers are very restricted in what they can tell you—often no more than to verify that the person did work there and the dates of employment.

    Sometimes a co-worker will provide more information. You may hear the name of a company the subject worked at that is not on the list he gave. Did something happen there that he does not want to tell you? The investigator should call that company, check if the subject worked there and try to get more information.


  3. Follow-Up on Issues Raised During the Background Check.

    At this stage, there is additional information to be explored:

    • Fully investigate discrepancies and/or omissions
    • Consider the possibility some queries resulted in inaccurate information and follow up all leads to check for accuracy.
    • Fully synthesize all the data to insure there are no obvious discrepancies or missing pieces, conducting additional queries if an issue remains unclear.
    • Document all relevant information about a trader or fund manager, together with any clarifications or explanations by the subject himself.


  4. Safeguard the Subject's Personal Information and Know the Laws.

    A good investigator does not dig for dirt that is irrelevant to the verification. Some personal events, say a divorce, may not be germane to an investment decision.

    Investigators should know the laws and regulations regarding the use and safeguarding of sensitive information For instance, the Fair Credit Reporting Act requires that the subject be informed of the credit check. Sometimes credit reports are inaccurate and the subject should get a chance to correct mistakes. It is the investigator's responsibility to properly handle credit reports.

    After the process, the completed background report and supporting documents should be carefully secured.


  5. Monitor the Manager and Firm After the Check.

    You need a way to periodically update the report. There may be new developments relevant to your investment. This is something to discuss with the investigator.



 
This article was published in Opalesque Futures Intelligence.
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