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Gradante Renews Calls to Outsource Hedge Fund Audits

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The need for new regulations that will help protect investors and reduce systemic risk as well as cut down on the potential for fraud is on the minds of not just legislators and regulators, or investors and their advisors, but just about anyone with any kind of stake in the financial markets. In short, it’s something everyone is talking about.

Charles Gradante, co-founder of the Hennessee Group LLC, the New York-based consultant and advisor to direct investors in hedge funds, has been making recommendations to address these issues regarding hedge funds for more than a decade.

On April 21, the firm released a summary of suggestions Gradante has made since 1998 to the House of Representatives, the Senate Banking Committee, the Securities and Exchange Commission, and the Commodities Futures Trading Commission.

High on his list is a recommendation that the SEC outsource hedge fund fraud audits to third parties that have “the forensic skills and the ‘street smarts’” to take on the task. Gradante further suggests that the limited partners in hedge funds select the company to perform the fraud audit rather than the general partners, and that the auditor then issue a “fraud audit report card” back to the limited partners as well as to the SEC.

Toward the end of reducing systemic risk, Gradante suggests assigning the equivalent of a CUSIP number to each hedge fund and then using that number be to monitor leverage extended by commercial banks and prime brokers.

Perhaps the most common sense of his suggestions is that the “know your customer rule” once again become a fundamental precept in the banking business. If the lender can’t see the balance sheet or is not comfortable with it, then there should be no extension of credit.

Tying all of his themes together is what Hennessee calls the “Gradante Gatekeeper Concept,” which “states that all gatekeepers should have a vested interest in ensuring the integrity of the hedge fund industry for investors. It should be mandated that gatekeepers are accountable and responsible.