Mike Norman, anchor, HardAssetsInvestor.com (Norman): Welcome back everybody. I’m Mike Norman, your host. We’re here for the second half of my interview with Monty Agarwal, who is the author of the new book “The Future of Hedge Fund Investing.” Let’s talk about ... you have a chapter in there, the “Five Inviolable Commandments” for hedge fund investing. What is that all about?

Monty Agarwal, author, “The Future of Hedge Fund Investing” (Agarwal): Right. I mean, obviously as we saw in 2008, the biggest Ponzi scheme in the hedge fund was Bernie Madoff when he stole $65 million. What I’ve done is come up with a very concise list of five things. If investors were to just follow those five things, at least it will avoid them losing money to the next Ponzi scheme.

Norman: Really? Five things?

Agarwal: Just five things.

Norman: What are they?

Agarwal: Very simple. One, when you’re conducting your due diligence on a hedge fund manager, make sure he has an independent, well-recognized auditor. No. 2, make sure there’s an independent custodian – somebody who’s holding your cash and your assets and it’s not the hedge fund manager who’s holding it. Three, an independent prime broker, so the hedge fund manager is not executing the trades themselves and cooking up the fictitious trades. They’re being done by a third party. No. 4, independent NAV calculations, so you know the returns, so the hedge fund manager’s postings are actually calculated by an independent party. And he’s not sitting there saying, “Oh yeah, I’m up 30 percent.” And No. 5 – very important – the manager is willing to sit down with you across the table and in very simple English explain to you how he generates returns.

Norman: Now if the folks had that checklist of five things, would they have avoided getting into that Madoff situation?

Agarwal: Very, very easy; yes.

Norman: Really?

Agarwal: Not just Madoff, but I’ve actually done a case study, and I mention in my book the last five or six big hedge fund scandals. And you don’t even have to go down the list; just the first one off the list would be like, “Okay, fine; that’s a red flag. I’m not going any further.”

Norman: Do you think that greed is a part of it in a … I’m talking about on the part of the investor. Like they’ll see a guy like Madoff or somebody who purportedly has these unbelievable returns, unmatched, and they want to get in so bad that they’re willing to kind of skirt over the five points or doing the due diligence.

Agarwal: Do you know, I know a lot of high-net-worth individuals, especially down in Palm Beach, who conduct more due diligence on a $100,000 car than they would investing $10 million?

Norman: On a $20,000 used car. I mean, they’ll kick the tires.

Agarwal: Exactly.

Norman: But then they’ll wire $10 million into some trader’s account.

Agarwal: Exactly.

Norman: And for them it’s like cocktail party chatter: “Hey, I’m in Madoff’s fund.” It was like social status.

Agarwal: Of course.

Norman: It was part of the marketing … I guess you could call it a genius. It was an evil kind of a genius. But he made it so that that was part of your social status that you go in, right?

Agarwal: Absolutely. The first chapter in there, actually, has a lot of anecdotal, entertaining tidbits about that.