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Additionally, it could be asked, why does the MSA only require independent custody it for larger managers? Perhaps a custody related fraud below S$250 million does not outweigh the burden and costs of hiring a third-party custodian placed on smaller fund managers in the mind of the MSA, however such considerations would likely hold little recompense for the investors who could lose capital in such a situation. Requirements for independent valuation of investor assets "Independent" is a vague term at best. Does this mean that a hedge fund that trades highly liquid positions such as equities, and is able to price such positions from a third-party source such as Bloomberg, has satisfied this requirement? Or instead is the work of a third-party firm engaged by the hedge fund manager, such as a fund administrator, required? Does this mean that it is now a violation of the Singapore regulations for FCM's to self-administer? What about situations where positions are thinly traded or initially manager marked? Would the hedge fund manager hiring a third-party administrator, who may not have the competency to independently price such thinly traded positions, still satisfy this requirement? An overarching concern relating to the use of such third-party administrators is that administrators themselves are hired by the fund managers. While they work for the fund, there are legitimate questions about the true independence of such relationships. Requirement for FCMs to undergo independent annual audit by external advisors Would this requirement be satisfied by a hedge fund managers regular annual financial statement audit Does this "new" requirement mean that it was previously fine for a manager not to be audited? Once again, it seems the MSA is finally catching up to what is common sense to investors. While investors should in no way outsource their operational due diligence responsibilities to a third-party auditor, the work of an auditor and the subsequent financial
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has unfortunately stopped short in its attempts to implement real oversight and reform. By setting artificially low limits for hedge fund transparency and independence, the MSA has demonstrated that it is still partially a captured regulator in the shadow of the hedge fund industry it seeks to regulate. One of the more concerning themes of the recent MSA reforms is the shifting of the onus towards hedge funds themselves. It is up to hedge funds to ensure adequate risk management procedures are in place and that assets are independently valued. Yet, the MSA stops short of saying how it will police these items. Effectively, the MSA is hoping the largest hedge funds play by the rules and will likely utilize these new regulations as a fee generation tool to issue technical fines. Unfortunately, pomp and circumstance seem to have won the day, and little actual ongoing oversight will be performed. With this new regulation the MSA has asked investors to shoulder the burden of hedge fund oversight and due diligence. While the recent MSA reforms are a step in the right direction, it is unfortunate that meaningful hedge fund regulation has yet to come to Asia. Hopefully, it will not take an Asian Madoff to sound the alarm and cause regulators to take meaningful action.
design than an individual fund managers system Application backup - Fund managers may utilize cloud based solutions to serve as a backup location from which applications could continue to be run, in the event of a business disruption or disaster type event. The continued operation of applications during such an event may be particularly critical for quantitative or high-frequency trading strategies.
What should investors ask their fund managers about the cloud? The cloud presents a number of attractive benefits to fund managers. As part of an evaluation of a hedge funds BCP/DR planning, investors should take the time to understand how their fund managers may make use of such technologies. Some key issues investors may want to consider addressing include: What measures has the hedge fund taken to evaluate the BCP/DR planning procedures of the cloud provider? How does the hedge fund monitor the testing and oversight of the BCP/DR plan at this provider? What measures has a hedge fund taken to address security concerns related to storing data and running applications at third-parties? Does the fund manager incorporate testing of access to cloud based data and applications as part of its own BCP/DR tests? Has the fund evaluated the cost benefit analysis of utilized cloud based technologies versus bringing such technologies in house? At what point would any cloud benefits be outweighed by internal cost considerations?
How do fund managers utilize the cloud for BCP/DR planning? Hedge funds and private equity funds are increasingly incorporating cloud based components into their BCP/DR plans in several ways: Data storage - increasingly it is cost effective for firms to archive data offsite on cloud based servers. This reduces expenditures on new servers and frees up office space for other equipment and personnel Data backup - Cloud based data storage centers typically serve a high volume of customers and are therefore designed to handle large scale data transfers. These facilities are also typically designed with BCP/DR planning in mind, and may be more robust in both equipment and
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So consider for example, an LP who is considering making an investment in a private equity fund. This LP has wisely decided to perform operational due diligence on the GP. After the review, the LP has a list of several operational deficiencies and areas in which the LP feels compared to their peers the GP could improve. Continuing our example, let us assume that from the LPs perspective none of these items are so serious as to preclude him from investing, but rather he would feel more comfortable if the GP took corrective action on these matters. At a minimum, the LP feels it is important to make the GP aware of these issues. While previously a GP may have politely listened to such feedback and taken little corrective action, more LPs are increasingly monitoring how well GPs respond to this feedback. This includes performing ongoing operational due diligence to both monitor process improvements, as well as to detect any new operational risks. Clinging to their old ways, however, many GPs aren't frankly interested in this ongoing LP operational due diligence process or receiving any such feedback from LPs that have already committed capital. To facilitate this lack of dialogue, GPs utilize a structure whereby they have so-called advisory boards upon which typically sit the largest investors in a particular fund. As such, smaller LPs effectively become squeezed out of the process. More LPs are beginning to realize the flaws in such arrangements and have decided to become proactive not only in their due diligence efforts, but in engaging with GPs in more frequent dialogues concerning both investment and operational issues. A program of initial and ongoing operational due diligence for private equity can help ensure that an LP detects operational issues before committing capital, and is alerted to any new potential problems before they spin out of control. As this trend continues, LPs that do not engage in such programs may increasingly find themselves to be the exception rather than the norm.
PE LPs Are Utilizing Operational Due Diligence to Make Their Voices Heard
Increasingly, private equity investors, commonly referred to as Limited Partners or LP's, are performing operational due diligence prior to allocating to private equity funds. It is good to see that LP's have taken cues from their hedge fund counterparts, and are increasingly recognizing that private equity funds present just as many, if not more, operational risks to investors as compared to hedge funds. Unfortunately, private equity fund managers, commonly referred to as General Partners or GP's, have been slower than their hedge fund portfolio manager counterparts in listening to LP feedback. This is to be expected as GP's have long capitalized on the long-term nature of private equity investing to insulate themselves from frequent interaction with LPs. In the past, after an LP committed capital, there were little if any updates from GPs outside of prescheduled updates, generally quarterly, on portfolio performance. Such an arrangement has effectively robbed LPs of their voice as partners in the investing process. More LPs have come to acknowledge this fact, and are increasingly pro-actively sharing feedback with GPs after the initial and ongoing operational due diligence processes.
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Often times the equipment utilized in both internal hardware and external hardware situations is similar. Common types of information technology hardware and peripherals, includes desktop computers, routers and servers. In addition to this standard equipment, many fund managers may also have additional hardware, which provides backup power generation capabilities, such as generators or UPS devices. It is worth noting that each of these types of equipment is a broad umbrella term, which encompasses a wide variety of meanings. So for example, a fund manager could have several different types of servers (i.e. email/ Exchange server, SQL server, Blackberry sever etc.). It is important for investors to understand the different types of equipment in each category so that they can effectively evaluate the overall information technology function. Investors should take stock of a manager's hardware inventory when reviewing the information technology function during the operational due diligence process. With this inventory map in place, investors will have a roadmap by which they can navigate and evaluate the hardware review process. Do brand names matter? After an investor has developed an understanding of the types of hardware utilized by a fund manager, it is also important for investors to learn of the brand names of the manufacturers of such hardware. Certain types of hardware are considered to be of higher quality than others. Additionally, different types of hardware from different manufacturers may have different capabilities. By inquiring not only as to the types of hardware in place, but also as to the brand names of the manufacturers of such hardware continued on next page 2012 Corgentum Consulting, LLC
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Evaluating a fund's hardware infrastructure can provide valuable insights beyond just the specifics of the hardware. By asking more detailed questions during the operational due diligence process investors can glean information as to how the firm approaches other operational issues, such as business planning and scalability as well. Returning to our question of how much storage space is enough - there is no definitive answer. Each fund manager's situation will be different. However, investors should ask themselves if during the due diligence process they are asking the fund manager questions such as: How do you evaluate how much storage space you need? How much space do you currently have? Have you taken measures to plan ahead so that the firm's storage architecture is scalable?
By digging deeper into the hardware evaluation process during operational due diligence on information technology, investors will not only have a much more detailed picture of a fund manager's overall information technology framework, but also a better understanding on how those in charge organize their business.
and on the advice of their legal departments, prime brokers have become increasingly difficult to deal with. So for example, if an investor reaches out to a prime broker to ask certain questions regarding the nature of their relationship with a fund manager, many times prime brokers will send back generic responses that do not address the investors questions in detail. Furthermore, such responses are often rife with legal disclaimer language making them difficult to evaluate in certain circumstances. The onus is then put back on investors to follow up with the prime brokers to attempt to have their specific questions answered. In many cases, prime brokers may be unresponsive or slow to respond which can elongate the due diligence process and make it more difficult. However, just because it may be difficult does not mean that investors are not up to the challenge. By acknowledging the importance played by prime brokers, and constructing a detailed service provider review program which encompasses the specifics of prime brokerage relationships, investors will develop more comprehensive operational due diligence solutions, and perhaps avoid indirect exposure to the next Lehman.
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When some investors started asking questions the duo emailed investors screenshot of fictitious investor account statement from a completely made up investor named Mel Tannenbaum. The entire operation was a fraud and investors lost more than $3.5 million. Dragon and Provenzano used the money they stole to furnish an extravagant lifestyle, which included giving a $4,000 tip on an $18,241 bar bill in a Los Angeles nightclub. The two men face up to 20 years in prison and $250,000 in fines. A third co-conspirator named George Sepero is currently awaiting trial.
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The US is seeking to work in cooperation with international governments to enforce FATCA. In 2012, the US Treasury and the IRS released a statement alongside France, Italy, Germany, Spain and the US stating as much. The IRS' master plan is to allow non-US fund managers to deal more directly with international tax authorities and then the IRS would step in to collaborate. Although FATCA was signed into law in 2010, it does not technically take effect until January 1, 2013. Withholding for FATCA, what in IRS speak is known as so-called fixed or determinable annual or periodical payments or FDAP, will not begin until January 1, 2014. How do hedge funds and private equity funds comply with FATCA? In order to comply with FATCA, fund managers must provide US Internal Revenue Service ("IRS") with documentation on its investors. Specifically, those investors that have more than $50,000 invested outside of the US. Similar to anti-money laundering documentation, these documents include certain client balances, receipts, withdrawals and account identification numbers. Why do investors need to understand FATCA? Although FATCA will not take effect until 2014, there are a number of reasons why investors need to inquire now about their fund managers plan to comply with FATCA. The penalties for non-compliance are steep. If a fund manager violates FATCA, they will be penalized by a 30% withholding tax being placed upon the foreign financial institutions US assets or sourced income. This is a materially negative consequence and could have large negative implications for both investors and the fund. Additionally, because FATCA is effectively a US tax regulation which has international implications, there are privacy concerns raised.
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(iv) Classify investors into FATCA groups and ensure FATCA compliant documentation on each investor is maintained During the operational due diligence process investors should take measures to effectively vet the approach their fund managers take to FATCA before the IRS shows up at their door.
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On the Calendar
Please see below for a list of upcoming operational risk items of note and events:
Opal Family Office & Private Wealth Management Forum (Nappa Valley, CA)
October 24-26, 2012. Corgentum to monitor Private Equity panel Presented by Opal Financial Group.
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