Madoff’s Film Studio and the risks of outside business activities

It has been reported by Bloomberg that Madoff’s son Andrew and Nehst Media Enterprises LLC are being sued for $5.3 million. Nehst is a Madoff-funded film studio. The suit is being brought by allegedly wronged filmmaker Dana Offenbach whose production/director credits includes such independent films as Hav Plenty, Love & Orgasms and The Mamsahib.



Ms. Offenbach is seeking at $5 million in punitive damages and $300,000 in regular old-fashioned damages. Also named in the suit are Nehst Chairman Larry Meistrich and CEO Ari Friedman. The complaint alleges that Madoff was the “principal investor” in Nehst film studio. Here is a video about Nehst which is described as one-stop shop for independent film making that interestingly doesn't mention anything about the Madoff connection:



This suit highlights another important, yet often overlooked, aspect of hedge fund operational due diligence – outside business interests. Often times during the operational due diligence process investors are so focused on reviewing the risks associated only with the hedge fund manager that they often fail to cast a wide enough net to look at exogenous risks, such as outside business activities.

Any such activities are often important for a number of reasons. By way of illustration, suppose the Chief Investment Officer or lead Portfolio Manager of a hedge fund invests in a music company run by one of his close relatives, let’s say in this case his son. Continuing our example, when asked this question the standard hedge fund reply is often, “Mr. So-and-so does not devote a material amount of time to any external endeavors.” Some hedge funds may even go further and state, “All such external outside business activities must be approved by the firm’s compliance department.”

While all that sounds great, such activities often involve more than simply writing a blank check to a relative. Often times, and with the best intentions, the check writers/Portfolio Manager will be involved if not for the sole reason that they want to offer guidance to their relative and perhaps, albeit less noble an objective, look after their investment.

There is nothing inherently wrong with such external activities or investments. That being said, during the operational due diligence process investors should take steps to learn about these outside activities and determine what risks or distractions they may pose to a hedge fund manager. Many investors will be surprised to learn what external activities a hedge fund manager may be invested in. Knowledge of such activities will allow investors to make more informed allocation decisions and provide another data point by which to manage operational risk.

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