THE PAPER FILES are thick and stacked all around the meeting room. The cabinets are already full. It feels so much like a 1940s’ black-and-white movie that you really don’t want this to be anything other than a detective agency. The elevator ride up to the office adds to the effect – it’s stifling in Manhattan’s muggy summer air.
The main office is one big loft-like room. Fans whirr overhead. The bosses, Randy Shain and Chris Manthey, sit at one end by the window. Only the computers they and their employees have on their desks indicate that it is 2003.
It’s in this office, in the Chelsea district of Manhattan, that the two founders of BackTrack Reports, 10 years old this month, have built a successful niche investigative firm specializing in carrying out background checks for its financial-services clients on individuals in charge of companies that they are considering investing in.
The founders decided to start BackTrack mainly, says Shain, “because we felt we could”. But they had also become increasingly frustrated with their previous employer, investigative firm Bishop Services. “Randy was de facto head of the New York headquarters,” says Manthey. “But they wouldn’t promote him officially. They’d say it was because he didn’t have an FBI background, or because he wasn’t old enough.” The exact term they used, adds Shain, was “lack of polish”.
The mix of business they do might even serve as a useful proxy for the state of the economy, or at least the relative desire of financial professionals to invest. BackTracks spends much of its time these days investigating current and wannabe hedge fund managers, but it has not always been that way. “We’ve evolved into hedge-fund specialists,” says Shain. “But we still do other pre-deal checks. We follow the trend and market ourselves to what’s going on.”
In the late 1990s, for example, Shain reckons that around 40% of the firm’s business came from investigating executives at firms about to launch initial public offerings. Another significant chunk came from private-equity and venture-capital investors wanting to find out more about the people running the private firms they were considering ploughing their cash into.
The hedge-fund work was a smaller component then, but started to dominate after the tech bubble burst and the recession hit. The firm now claims to be the single-largest agency in the business. To date it has carried out background checks on about 2,000 hedge fund managers, which works out at roughly a third of all hedge funds, working on the generally held assumption that there are between 5,000 and 6,000 hedge funds operating around the world.
Keeping track of hedge hoppers Manthey and Shain’s experience affords them a unique perspective on the state of the hedge-fund world, and one that those still considering putting money into such alternative investments ought to take heed of. “There’s been an influx of people wanting to set up funds, often because there have been no other jobs available,” says Shain. “As a result hedge-fund managers are getting more spotty in their background and ability.”
He tells of one recent case in which they found, from a news article, someone who used to work with a new manager they were investigating for a client. “It turned out that this person was still working with the manager we were investigating, for at least 30 hours a week. He had portrayed himself to our client as someone who was already established with a fund and was just looking for extra cash. But he was still working on setting his fund up, and only doing so on a part-time basis. The client wasn’t happy.”
It’s not just about digging up the liars and potential fraudsters. It can just as often be about checking out a person’s capabilities. “Let’s say an analyst or someone who worked in mergers and acquisitions is setting up a fund,” says Shain. “They might be decent, honest, successful in their last job, but might not have traded before. They definitely represent more of a risk. They might lose all your money, but do so honestly.”
Shain and Manthey have seen problems develop in other parts of the financial-services business before, and they can at times be scathing in their comments. “There’s a lot more blame out there for the dot-com crash,” says Manthey. “People were going to VC firms with a business plan on a Tuesday, asking for $20 million and demanding a reply by Friday. And they’d get it. People threw professionalism out of the window.
“The whole approach was like betting on sport. They’d be looking to get it right three times out of 10, for example, hoping these would more than wipe out any losses on the others. We’d try to explain that we might be able to weed out the two or three among their 10 investments that might be in the whiff category, the ones that could go bad.”
Throwing cash around It’s a similar story for some of those setting up hedge funds, they say, and among the chief culprits are the investment banks. “As institutions, many of them are determined to create their own hedge-fund products and funds of funds, but not all of them get it,” Manthey says. “A lot of them have the same throw-around attitude to the money that venture capital firms had in the late 1990s.”
That contrasts starkly with what Shain calls the professionalism of their best clients, the independent fund of funds companies. “We have four of the 10 largest as clients,” says Shain. “We don’t tell them what to do, but they listen and pay attention. They really care. They don’t have the mentality that having one fraudulent hedge fund in their portfolio of 20 is okay and will be covered by the other 19.” That’s not just a question of fund of funds managers being smarter, though, Manthey explains. “They can just move to another fund, and do so overnight, if there’s a problem. Others, though, might have to wait months to get their money out.”
Unlike most of their competitors, neither Shain nor Manthey is a former policeman or FBI officer, and that suits them just fine. “Most of the other companies in this business have government models, and are law-enforcement based,” says Manthey. “We don’t get involved in security for hire, though. Ours is just about providing background checks.”
As a result they tend not to hire too many former FBI or police officers. Instead a lot of their investigators are former journalists. “The premise is that the work here is more akin to investigative journalism,” says Shain. “We’re not averse to hiring people with a law enforcement background, but the skills are not always the same. There’s usually a huge amount of information to get through, and who better to distil that than a writer. And it’s not all about databases and tracking down records, but interviewing people as well.”
The past three years have been a good time to pick up journalists as staff, he says. “It’s been a buyer’s market. There were a lot of refugees from new media and magazines after the stock market crashed, and a lot of newly qualified journalists in New York who didn’t want to cut their teeth on a paper in Iowa.”
They’ve helped establish the leading franchise for investigating hedge fund managers. Now it looks as if other businesses might slowly be coming back to life just as the lustre of alternative investments is dimming.
In mid-summer, for example, Shain says he received the first call in about three years looking for IPO investigation work that they’d had. Private equity is also making a tentative comeback. “The work’s starting to dribble in again,” says Shain. “Investors are either looking to spend new money or are looking to fix old deals, such as hiring a new CEO.”
