Hedge fund administration is part of a burgeoning cottage industry that attempts to make funds more transparent to investors. Administrators make sure that trades have occurred, and that the net asset value (NAV) of a fund’s portfolio is copacetic. They also try to ascertain whether a fund has the assets that it claims to own — no small thing in the wake of some infamous frauds, including the massive sham operated by Bernie Madoff.

But there is one small fly in the ointment: Administrators often obtain pricing information from the hedge funds themselves, and are not obligated to check that the information they get is correct. It’s akin to a credit rating agency getting the information about a mortgage-backed security from the bond issuer, and not having to make sure that the data is realistic.

“There’s no law that requires any vendor to verify assets under management,” says Ron Geffner, a partner at law firm Sadis & Goldberg who structures, organizes and counsels hedge funds. He adds that investors need to remember that administrators aren’t working for them. They’re hired by the hedge funds.

An administrator’s job gets trickier and more expensive depending on what a hedge fund trades. For liquid stocks and bonds, an administrator can easily buy data from ThomsonReuters or Bloomberg. If administrators have to track currencies, commodities, or derivatives, they may have to pay for information from a different data provider. And for illiquid securities, it can get very expensive for an administrator to go out and verify those prices.

“Usually only very large administrators can afford a lot of data vendors,” says Tanya Beder, who is the chairman of consulting firm SBCC group and who has also served on the board of an administrator. “So administrators often make deals. They agree to do independent pricing on the stuff that they can, and get prices on everything else from the hedge fund.”

Geffner notes that the extent to which an administrator relies on a specific hedge fund for pricing information is usually described in the offering documents. But investors often don’t take the time to understand that relationship.

Forbes recently ran a story about investors caught up in a hedge fund fraud who claim they were burned by Citco, the world’s largest hedge fund administrator. According to the story, a hedge fund called Lancer would buy restricted stock in a worthless shell company, as well as a few shares on the open market at a higher price in order to show a gain. The artificially inflated value was given to Citco, the fund’s administrator; Citco used the data in monthly statements to investors.

In a subsequent lawsuit, some Lancer investors claimed that even after they told Citco that they were concerned about the fund’s NAV, the administrator continued to send out reports with “misleading” valuations at the behest of the hedge fund. Citco responded to the Forbes piece by saying that it did all that it was required to do, which points to a reason why administrators may be absolved of wrongdoing: When bad things happen, they—like the rating agencies — are allowed to rely on someone else’s data.

That’s why smart investors will ask to see the positions in a fund. For assets that don’t trade, or trade very little, they should work to find out what prices other hedge funds and broker-dealers that deal with similar assets are reporting.

That’s the kind of price discovery that some so-called sophisticated investors are unwilling (or unable) to do. But it’s still important for investors to feel like they can verify that asset values are right, in part because the administration business is consolidating. Hedge funds aren’t willing to pay enough to cover the cost of gathering all the data, which is making it difficult for smaller administrators to survive.

“If we don’t get at the root of ongoing problems, they become entrenched as players vanish,” says Beder. “Then you get the pro-cyclicality problem that we saw during the financial crisis. Everyone was doing the same thing, but no one was doing the right thing.”

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Notes from behind the hedge…

** Events: The Wall Street Women Forum is coming up this Wednesday, an invite-only happening for senior level women who want to learn how to form relationships and learn skills that will help them get to the top of whatever ladder they want to climb.

** Another day, another study: Hedge Fund Research reports that hedge funds gained in April, but not as much as the S&P.

** In case you missed it: Senator Charles Grassley now wants to probe the “potential scope of suspicious trading activity” at Steve Cohen’s SAC.

And if Cohen gets his minority stake in the Mets, he could be an intriguing addition to the management team.

Hedge fund managers pepper the Sunday Times Rich List of the 1,000 wealthiest people born or based in Britain. Attara Capital co-chairman Nat Rothschild and Sail Advisors chairman Robert Miller topped the list. They’re each worth about $1.6 billion.

Some hedge funds are getting crushed by commodities prices.

Seth Klarman’s $24 billion Baupost Group is opening its first overseas office this year to take advantage of Europe’s sovereign debt crisis.

A new novel portrays a world where hedge funds are a hotbed of intrigue, sex, and murder… rather than a world filled with Bloomberg terminals, dumpy guys yelling into phones, and lunches at mediocre steakhouses.