Two former hedge fund managers were each sentenced today to three years in prison for defrauding investors out of nearly $1 million. 
 
News of the scheme is especially unsettling on the eve of the implementation of the JOBS Act, which will permit hedge fund managers to advertise to accredited investors for the first time.
 
The two individuals — Michael Karz and Christopher Fardella — had already pled guilty in October 2011 to one count of conspiracy to commit securities fraud and mail fraud and one count of securities fraud. The pair and two others, described by federal prosecutors as co-conspirators, were partners in KMFG International, a Florida-based hedge fund.
 
According to the government, they used cold calls to raise about $1 million from investors. They were found to have misled investors about their firm’s principals and financial performance.
 
For example, KMFG’s marketing materials falsely claimed it was operated by “a management team consisting of hedge fund managers, traders and top level executives from independent oil and gas companies” with a track record of generating “cumulative returns for 30 months of over 165 percent.”
 
In reality, they had no experience running a hedge fund and were never top level executives in the oil and gas industry. The firm had no track record and never made a profit for any of its investors.

“In order to lure investors, Michael Katz and Christopher Fardella created resumes and marketing materials for their phony investment fund out of whole cloth,” says U.S. attorney Preet Bharara, in a statement. “Their sentences demonstrate to those who may consider similar schemes that smoke and mirrors will not fool law enforcement, and you will be held accountable for such fraudulent activity.”

In the end, Katz, Fardella and the other co-conspirators either lost or spent $981,000 out of the $1,031,086.16 collected in investor funds.
 
Once the JOBS Act goes into effect, brazen schemers will be enabled by their ability to advertise. Suddenly, nobodies — with neither track records nor solid resumes — will no longer need to rely on just friends, family and word of mouth to raise money.  

Sure, you can say if someone wants to commit a crime, they will find a way to do it.
 
However, what I fear is that the vast majority of hedge funds that will advertise in the beginning will be those small funds with law-abiding no-names with little track records seeking to raise capital in a weak capital-raising environment.
 
So, it would make it harder for an accredited investor not tuned into the word-of-mouth network to ferret out the legitimate no-name manager with scant history from the phony, ill-intentioned ones. And those phony, ill-intentioned funds can begin to prey on wealthy investors, who would not previously have been inclined to invest in hedge funds, by making glistening promises of huge returns.

My first advice: If someone claims to have generated cumulative returns for 30 months of over 165 percent, and you never heard of them and can’t find any mention of this accomplishment in an article from a legitimate media organization, stay away. No matter how tempting.