The hedge fund industry isn't the most transparent, leaving institutions in a bit of a pickle when it comes to due diligence. More people seem to be taking an aggressive approach, actually hiring investigators to take a close look. First Advantage Investigative Services has looked into more than 5,000 hedge managers. The biggest red flags that have popped up so far have been bankruptcy and involvement in civil suits. One manager was sued for not paying rent, which has to make you think twice. In the end, a clean past is not necessarily a guarantee of future success. 

For more:
- here's an interview with Investment Dealers' Digest

Related articles:
When hedge funds just aren't fun anymore. Article
Fund managers turn risk averse. Article
Funds of hedge funds not faring that well. Article