Importance of Operational Due Diligence

As independent due diligence experts, we don’t tend to report on new ventures in the industry, but this one has certainly caught our attention. In January 2013, a new family office called Talhuddex was founded by Mr. Michael Balboa, which will “focus on long term private investments”. The name of the founder should sound familiar, and if it doesn’t then it’s surely concrete evidence as to why our work should never stop.

Mr. Balboa is an ex-portfolio manager who was involved in the now-famed Millennium Global Investments Limited (“Millennium”) fraud. The family office’s website includes a biography of Mr. Balboa, noting his extensive experience in the financial services industry, both in terms of traditional and alternative complex investments. Unfortunately, what is doesn’t include is the fact that Mr. Balboa was charged by the US Securities and Exchange Commission in 2011 for securities and wire fraud.

As you are reading this newsletter, Mr. Jerome de Lavenere Lussan, CEO of Laven Partners is addressing the audience at theAmsterdam Investor Forum 2013 and presenting Millennium as a case in point. Laven Partners makes continuous efforts to improve and educate the hedge fund industry, and will use the highlights of Millennium as a case study for illustrating the need for thorough due diligence.

Millennium Global Emerging Credit Fund Limited (the “Fund”), which pursued a long/short emerging markets credit strategy, posted eye-catching returns and had assets under management of USD 811 million shortly before its collapse in August 2008. In addition, reputable service providers had been contracted to service the Fund, yet even this could not prove enough of a safety net for what would be later discovered by the prosecutors.

The official court complaint detailed a fraudulent scheme to overvalue 2 illiquid and sizeable positions owned by the Fund. Over the course of 8 months in 2008, 2 ostensibly independent brokers that were enlisted by Mr. Balboa himself made “phony mark-to-market quotes” to a valuation agent. Furthermore, Mr. Balboa ensured throughout the scheme that the Fund’s auditor believed the marks were genuine counterparty quotes from an independent source, when in fact it was Mr. Balboa who was providing the brokers with prices for the securities. This led to overstating the Net Asset Value by about USD 163 million, generating illicit and inflated management and performance fees in the meantime.

Background checks on Mr. Balboa may well have raised a few concerns. Mr. Balboa’s previous ventures, VZB Partners and Rainbow Advisory Services, of which he was a co-founder, both seem to have ceased operations without a clear explanation. Also, on 8 November 2006 Millennium received a Direction from the Financial Services Authority (“FSA”) requesting a written confirmation from the firm that Mr. Balboa had the required technical and regulatory knowledge, skills and expertise to carry out his responsibilities. This information was publicly accessible on the FSA’s website and could have been found by any potential investor exercising comprehensive due diligence.

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