Investors are understandably concerned about the security of their assets, but if you follow a few simple rules odds are you will be OK - after all there are 8000 hedge funds and only a couple of Ponzi schemes.
1: A fund that uses an outside custodian will have great difficulty in pulling off a multi year scam. That's because the custodian sends a 1099r report to the IRS. When your fund files its tax return those trades have to match up, or every investor in the fund is going to get audited by the IRS. Of course, an intra year rip off is still entirely possible.
2: Get to know the fund's CPA. Call him up, make nice. Ask questions.
3: Get to know the fund's custodian. Some are well known, brand name shops like Fidelity or Goldman Sachs. Those names always give me that warm and fuzzy feeling I need to have about my money, but there are many smaller shops that are equally as secure. KNOW WHERE YOUR MONEY IS BEING HELD!
4: I don't let my investors send me all of their money. I tell them they need to have at least 1 other manager, and if they are really rich, as many as are necessary. If your fund wants every last dime you have... well, they are not considering your best interests (IMHO).
5: Desperate people do desperate things, so its best not to tempt desperate people. I can't emphasize this one enough. Is your manager a high flier? Fancy Schmancy? Have a history of litigation or unpaid bills? Signs of drug or alcohol abuse (we all know what they are)? Weekends in Vegas, showgirls, private jets, and Bentley cars? These are BAD signs. Used to be folks knew their banker and his family. Get to know yours. I am not saying the guy has to be Jimmy Stewart, but grounded, family-type-guys, living modestly are usually rational enough to understand the consequences of violating their fiduciary responsibilities (going to prison).
Just thinking out loud...