Hosted by Garrity Graham and co-hosted by PRMIA:

Hedge Funds and Fraud: The Future of Due Diligence

11:00 -12:30, March 19th, 2009 Webinar

Hedge Funds and Fraud: The Future of Due Diligence

Introduction

Welcome and Session Instructions Order of Presentations:

The Psychology of the Gullible Investor
Stephen Greenspan Ph.D., Clinical Professor of Psychiatry, University of Colorado

The Profile of a Fraudster

James Tunkey, I-OnAsia

Current Legal and Regulatory Requirements for Hedge Funds

Philip Thomas, Esq., Garrity Graham

A Hedge Fund Insider's View

Samuel Won and Greg Ivancich, Global Risk Management Advisors, Inc.

The Regulatory Future for Hedge Funds

Philippa Girling, Esq., FRM, Garrity Graham

Q&A Session Ends

Hedge Funds and Fraud: The Future of Due Diligence

The Psychology of the Gullible Investor Presenter: Stephen Greenspan, PhD

Presentation: The Psychology of the Gullible Investor

Presenter: Stephen Greenspan, PhD Affiliations: Emeritus Professor Educational Psychology, U of Connecticut Clinical Professor of Psychiatry, U of Colorado Med. School Website: www.stephen-greenspan.com Contact: stephen.greenspan@gmail.com

Steve

New book: ANNALS OF GULLIBILITY Published Jan 09, Praeger Publishing Available at amazon.com ($36)

________________________________________________ Cover Illustration In the Jan 3 issue of the WALL STREET JOURNAL Why We Keep Falling for Financial Scams Headline: Intelligent people have long been ruined by frauds. Psychologist Stephen Greenspan, who specializes in gullibility, explores why investors continue to be swindled -- and how he came to lose part of his savings to Bernard Madoff Link:
http://online.wsj.com/article/SB123093987596650197.html

FOOLISH ACTION

PRACTICALLY FOOLISH ACTION

SOCIALLY FOOLISH ACTION

NONINDUCED

INDUCED (GULLIBLE)

FIGURE1 TYPES OF FOOLISH ACTION

Three types of foolish actionPractical; Noninduced-Social; Induced-Social (Gullibility)

______________________________________________________

Gullible Act

Situation

Cognition

Affect & State

Personality

My four-factor explanatory model of gullible (induced socially foolish) behavior

Situational (External) factors contributing to investor gullibility:

Robert Shillers feedback loop (people telling other people about their gains) lies at the heart of all Ponzi schemes and investment manias Social feedback loops apply to fund managers as well as investors (smaller funds taking their cues from the behavior of larger funds) Investments seem safer when they are within fund families that have good reputations (such as the Rye/ Tremont feeder fund that I invested with) Scam artists are skilled manipulators who engage in tricks such as playing hard to get, and they understand the basic trusting nature of most people Investors often lack other around who can protect them (for example, widows who formerly relied on their husbands) This factor also explains the affiliation angle (why so many victims tend to be from the same religious community, for example)

WITHIN-PERSON (INTERNAL) FACTORS . Cognitive factors contributing to investor gullibility: Investors often lack any knowledge of investments or any ability to evaluate the risks and rewards of a proposed investment Investment schemes (especially fraudulent ones) are often mysterious and difficult to understand Personality factors contributing to investor gullibility: Some people are extremely impulsive and quick to take risks Some people are too trusting of people and reluctant to check them out Obsessional personality can lead to resisting diversity Emotional factors contributing to investor gullibility: Greed (wanting far more than one needs) is a big motivator Fear of losing ground (need for assurance) ironically can make one vulnerable to loss

HOW INDIVIDUAL INVESTORS CAN BECOME LESS GULLIBLE

Diversify, diversity, diversify (dont put your entire future at the hand of one scheme or one individual) Take your time (hasty decisions are more likely to be foolish) Seek alternative sources of advice Recognize the limits of ones expertise (smart people often think they are smart about everything) Be satisfied with enough and dont try to make more just because others seem to be doing better Take responsibility for your investments and dont be too passive Recognize that while gullibility will always be with us, you dont have to be a victim

Website: www.stephen-greenspan.com

Contact: stephen.greenspan@gmail.com

Hedge Funds and Fraud: The Future of Due Diligence

The Profile of a Fraudster Presenter: James Tunkey, I-OnAsia

ABOUT I-ON & SPEAKER JAMES TUNKEY

Amman Bangkok Beijing Guangzhou Hong Kong Kuala Lumpur London Johannesburg Melbourne Mumbai New York Rome Shanghai Shenzhen Singapore Tokyo Vancouver Warsaw I-OnAsia (www.ionasia.com.hk) is an international business intelligence and security consultancy serving the hedge fund and investment community. Founded in Hong Kong in 2001, I-OnAsia has grown as an international boutique with 18 offices worldwide. I-Ons team of over 100 full-time professionals have military, intelligence, and law enforcement backgrounds. I-Ons principals have worked together for more than a decade. Mr. Tunkey has over 15 years of experience in due diligence as a business intelligence specialist, a financial journalist, and U.S. government analyst. He is often involved in transactions requiring both a strong understanding of the steps necessary to determine an individual or teams activities and motivations, and of the complex global financial system within which his subjects conduct business. He has advanced law enforcement training in the conduct of interviews, government experience, unique education in corruption control, and has managed deal investigations teams working on many of the worlds largest transactions. Mr. Tunkey also helps companies establish internal security and fraud departments, and benchmark performance against industry best practices. He is the volunteer Regional Director of the PRMIA New York chapter. His PRMIA blog on risk is found at www.prmia.org/Weblogs/General/James_Tunkey. Mr. Tunkey also serves on the boards of the International Council for the Life Sciences and the World Water Center. He is a member of the Council on Foreign Relations and the International Institute for Strategic Studies, amongst other organizations.

CONTEXT
6 Feb: Federal Reserve Bank of New York President and CEO William C. Dudley states at CFR he expects the hedge fund universe to be reduced by 50% in the near future. We are in a period of redemptions and low trust in counterparties. Madoff, Stanford et al dont help market confidence. Earlier in the week, AIG repeatedly described in press as operating as an internal hedge fund. Operates outside of regulatory tent. Allegedly assists European banks dodge Basel capital reserve requirements. BofA investigating Merrill hidden losses and non-transparency. Meanwhile in US Congress: SEC and NY insurance regulators admonished for missing Madoff, AIG, others. Housing bubble full of perverse incentives. AAA and models for valuing firm and transaction creditworthiness in tatters.

How much money do you need?... You could get a million dollars. And you could get it in cash I know where it could be gotten I mean its not easy, but it could be done But, uh, the question is who the hell would handle it?... Let me say there should not be a lot of people going around getting money. Richard Nixon

INCENTIVES, STRUCTURES, CONTROL SYSTEM

Yes, (best of present and) the future of due diligence does include profiling for fraud. Fear may likely be the driver for fraud for next 2-3 years with deleveraging and redemption pressures affecting management judgment. Tier 1 long established teams and particular individuals may also be motivated to fraud (perversely) by honor, and there are many sacred cows. Greed always a problem, and was the primary motivator in the boom. Current fraud prevention best practice is to identify key risk indicators on operational risk / background check and compare with other assessments of level of transparency and risk disclosures. Rigorous profiling is essential, as is the need to revisit individual assessments annually or bi-annually. But it this due diligence must be placed in its proper context. Missing in the prior period was a realistic understanding of the control systems faults. What are the levers of control over the subject? How have they been tested? What are the terms of accountability? These affect the profile. Redemptions (and market failure in general) unlikely to halt until these market and government regulatory weaknesses are addressed directly. Also there must be greater attention paid to internal weaknesses. This goes beyond often weak bench strength (e.g. publicized reports of pre-allocation decisions in Madoff funds). It also addresses the vulnerabilities to fraud caused by internal staff.

Dont come to the table with the same worn arguments and tired ideas that helped to create this crisis. Barack Obama

Hedge Funds and Fraud: The Future of Due Diligence

Current Legal and Regulatory Requirements for Hedge Funds Presenter: Philip Thomas, Esq., Garrity Graham

Hedge Funds and Fraud: The Future of Due Diligence

A relentless SEC and Angry Investors: Uncovering and Managing Hedge Fund Legal Risk

Former SEC Chairman Christopher Cox. "Hedge funds are by no means unregulated when it comes to fraud. Those who commit fraud at the expense of investors will always be the target of a relentless SEC. http://www.sec.gov/news/press/2008/2008-115.htm

Hedge Funds and Fraud: The Future of Due Diligence

The Legal Environment

Private litigation
Bear, Stearns & Co./ Manhattan Investment Fund Ltd. Banc of America Madoff

SEC Enforcement Actions:

MedCap Management & Research (Fiduciary Duty) Thompson Consulting Inc. (Misrepresentation) WealthWise LLC (Undisclosed Conflicts of Interest)

Hedge Funds and Fraud: The Future of Due Diligence

Hot Regulatory Topics

Disclosure Potentially Manipulative Practices Valuation

Hedge Funds and Fraud: The Future of Due Diligence

Tools for uncovering legal and regulatory risk (but are they enough?)
Good
The DDQ Form ADV Interviews with manager Obtain customer references

Better
Background investigation of principals and PMs
Check state and federal criminal and civil cases Credit check if possible Google! Private Investigators?

Hedge Funds and Fraud: The Future of Due Diligence

Best

1. Never take the fund managers word for anything. 2. Be suspicious of managers limiting access to information. 3. Create state of the art legal documents and structures. 4. Consult specialist professionals who will be able to spot irregularities. 5. Pay attention to what the industry leaders are saying and doing about best practices.

Hedge Funds and Fraud: The Future of Due Diligence

What a simple background check might have uncovered

MAR/Hedge (RIP!) No. 89 May 2001

(Google is still free!)

Hedge Funds and Fraud: The Future of Due Diligence

Resources
Alternative Investment Management Association. www.aima.org
Provides industry standard due diligence questionnaire to its members (somewhat tailored to UK funds). Offers specialized DDQs (e.g. for FOHF managers, for single funds etc.)

FINRA BrokerCheck. Run report, including disciplinary history, on FINRA-registered individuals and firms.
http://brokercheck.finra.org/

Investment Adviser Association. http://www.investmentadviser.org

Provides a number of risk assessment guides and charts (all free)

Investment Adviser Public Disclosure website. Pull potential investees Form ADV Part I(if RIA).
http://www.adviserinfo.sec.gov/IAPD/Content/IapdMain/iapd_SiteMap.aspx

Managed Fund Association. http://www.managedfunds.org/

Provides both the Sound Practices for Hedge Funds guide and a fillable DDQ (both free)
http://www.managedfunds.org/downloads/Sound%20Practices%202007.pdf http://www.managedfunds.org/downloads/Due%20Dilligence%20Questionnaire.pdf

OFAC Search Tool. Determine if investor or counterparty is listed in the Office of Foreign Asset Controls Sanctions Program Listings.
http://apps.finra.org/rulesregulation/ofac/1/Default.aspx

The Presidents Working Group on Financial Markets, Asset Managers Committee Report.
www.ustreas.gov/press/releases/reports/amcreportapril152008.pdf http://www.investmentadviser.org/eweb/dynamicpage.aspx?webcode=PublicDocs_Websites

The SEC has published its enforcement manual for the first time.
www.sec.gov/divisions/enforce/enforcementmanual.pdf

Hedge Funds and Fraud: The Future of Due Diligence

A Hedge Fund Insider's View Presenters: Samuel Won and Greg Ivancich, Global Risk Management Advisors, Inc.

Global Risk Management Advisors

Webinar Presentation

Risk Management at Hedge Funds Issues and Challenges

March 19, 2009

Samuel K. Won Founder/Managing Director Global Risk Management Advisors, Inc. swon@grmainc.com

Gregory M. Ivancich COO/Managing Director Global Risk Management Advisors, Inc. givancich@grmainc.com

Global Risk Management Advisors

Why Hedge Fund Due Diligence Failed

Understand the Secular Context Breadth and Depth of the Due Diligence Background and Experience of the Due Diligence Team Formality vs. Investment Process

Global Risk Management Advisors, Inc. swon@grmainc.com 212-230-1610

givancich@grmainc.com 212-230-1661

Global Risk Management Advisors

Why Infrastructure and Processes Matter

Unprecedented and Historic Events Sea Change in Regulatory Environment Institutional Requirement Competitive Differentiator Emerging Best Practice Standards
Global Risk Management Advisors, Inc. swon@grmainc.com 212-230-1610 givancich@grmainc.com 212-230-1661

Global Risk Management Advisors

The Need for Independence In-house versus Outsourced

Economies of scale Advantages and disadvantages

Value of Third Party Review:

Pricing and valuation of Illiquid Investments Infrastructure, processes and controls Review of investment style and process
Global Risk Management Advisors, Inc. swon@grmainc.com 212-230-1610 givancich@grmainc.com 212-230-1661

Global Risk Management Advisors

Who we are:
Global Risk Management Advisors, Inc (GRMA) specializes in investment management advisory to asset managers and asset owners and in product development and strategic marketing for software companies and other service providers to the financial services industry. Our mission is to provide unparalleled independent advice to our clients that leverages our extensive industry experience and allows our clients to take advantage of our many proprietary applications and processes. Our aim is to assist our clients to meet their strategic business objectives and achieve sustainable competitive advantage in their respective markets. Every aspect of our advisory services to our clients has a strong embedded proprietary risk management element that distinguishes our approach from all others.
Global Risk Management Advisors, Inc. swon@grmainc.com 212-230-1610 givancich@grmainc.com 212-230-1661

Hedge Funds and Fraud: The Future of Due Diligence

The Regulatory Future for Hedge Funds Presenter: Philippa Girling, Esq., FRM, Garrity Graham

Hedge Funds and Fraud: The Future of Due Diligence

Global political reaction to current crisis will impact hedge fund regulation
British Prime Minister Gordon Brown met with President Obama at the White House March 3rd and the two discussed reform of financial regulation Finance ministers to meet in London on March 13th. G20 to meet in April in London to discuss global regulatory framework
Germany and France have pushed for deeper regulation than the U.S. on hedge funds and private-equity firms. Britain, which chairs the G-20 this year, generally has sided with the U.S. IMF pushing for more regulation, including hedge funds EU commissioners are set to endorse a regulatory restructuring plan. The proposal includes setting up a pan-EU systemic risk regulator attached to the European Central Bank. European leaders agreed in February that hedge funds must be regulated.

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Hedge Funds and Fraud: The Future of Due Diligence

US reaction
Treasury Secretary Timothy Geithner has promised more oversight over hedge funds
Including a registration regime

Hedge Fund Transparency Act

Introduced by Sens. Chuck Grassley (R., Iowa) and Carl Levin (D., Michigan) in an effort to boost regulation. Recent fraud cited as a reason to support the bill Demand that hedge, private-equity and venture-capital funds with $50 million or more in assets register with the SEC, reveal key bank relationships and give the value of their holdings. Anti-money laundering and suspicious activity requirements

CT proposed legislation
Minimum requirement from $1 million up to $2.5 million, with institutions needing at least $5 million in assets. Greater transparency by disclosing fees and other information about management or investment strategy. Obtain a state license as well as have an independent annual financial audit performed.

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Hedge Funds and Fraud: The Future of Due Diligence

US reaction (Cont.)
Credit Default Swaps
Possible clearing house for CDS Rep. Collin Peterson's bill and NY state proposed legislation to restrict, regulate or prohibit naked CDS

Supplemental Anti-Fraud Enforcement ("SAFE") Markets Act

Introduced by Sens. Charles E. Schumer (D-NY) and Richard Shelby (R-AL) Add hundreds of new investigators and prosecutors to nations financial fraud units

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Hedge Funds and Fraud: The Future of Due Diligence

Other changes

Possibility of a Hedge Fund SRO

Credibility issues The Alternative Investment Management Association proposals
U.K. trade group with members in many countries, including the U.S., said it plans to propose that hedge-fund managers agree to changes that many U.S. funds have resisted. The measures include registering with regulators and having regular contact with authorities about their businesses.

US Managed Fund Association

On Jan 29th expressed its support for the announcement of new legislation by Senators Charles E. Schumer and Richard Shelby, constructed to uncover and clean up financial fraud. March 5th announced its support for establishing a systemic risk regulator to restore investor confidence and ensure the proper functioning of capital markets.

Market pressures
Prime brokers classifying hedge funds and limiting access to services Due diligence requirements by investors impacted by recent fraud events

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Hedge Funds and Fraud: The Future of Due Diligence

What to do?

Anticipate regulatory requirements Anticipate increased due diligence requirements from investors Get involved with Managed Fund Association Put appropriate protections in place to meet regulatory requirements and build confidence of investors
Evaluate risk on a regular basis Ensure compliance risks are well managed Ensure AML and suspicious activity procedures are in place Conduct fraud risk assessments and training Review current documents for compliance and best practice Implement procedures and test them Be ready for an SEC visit Be ready for an enhanced due diligence visit
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Hedge Funds and Fraud: The Future of Due Diligence

Q&A

Hedge Funds and Fraud: The Future of Due Diligence

Thank You

Thank you for attending our session today. Send an email if you are interested in learning more about any of these topics.
Email: pg@garritygraham.com.

Hedge Funds and Fraud: The Future of Due Diligence

Appendix: Presenter Profiles

Philippa Girling is head of the Banking and Financial Services Practice at Garrity, graham, Murphy, Garofalo & Flinn PC. Ms. Girling joined Garrity, Graham, Murphy, Garofalo and Flinn, P.C. from Nomura where she was Global Co-Head of Operational Risk Management. At Nomura, Ms. Girling was responsible for the development of the global operational risk strategy to meet Japan FSA's Basel II requirements and for the implementation of that strategy in the Americas and Europe under local regulatory requirements. Previously, she was a founder and Program Director of the firm wide Operational Risk Department at Morgan Stanley. Ms. Girling also served as COO of the Global Financial Control Group and CAO of the Retail Brokerage Controllers Group at Morgan Stanley. She has 14 years experience in the global securities industry, working in the fields of operational risk, change management and project management. Ms. Girling has also designed and led many training programs, including an Operational Risk Executive Education program for Columbia University, NYC. Ms. Girling emigrated from the UK to the US in 1996. She has an English law degree, is a New York attorney and is a certified Financial Risk Manager (FRM). Stephen Greenspan is a developmental psychologist who is Emeritus Professor of Educational Psychology at the University of Connecticut and Clinical Professor of Psychiatry at the University of Colorado. An expert on social incompetence and foolish behavior, Steve wrote the first comprehensive scholarly book on human gullibility (susceptibility to being duped or manipulated through deceptive means). The bookANNALS OF GULLIBILITYcame out around the same time that Steve learned that he had been duped out of part of his retirement assets by Bernard Madoff through one of the so-called feeder funds. As a scholar, Steve thought this would be a good teaching case, so he immediately got a lengthy essay published in the Wall Street Journal explaining his own and others investor gullibility, using his four-factor theory of foolish behavior. Since then, Steve has gotten many invitations to speak to finance and other groups interested in better understanding how to help individuals and institutions to make more rational investment and other life-affecting decisions. Philip Thomas is a securities and regulatory attorney specializing in investment adviser compliance issues. He spent six years at Merrill Lynch in New York, and in 1996 was a key member of the team that brought to market Merrills first fund of hedge funds. From 2006-2008 he was Chief Compliance Officer and Deputy General Counsel of SB Schonfeld Fund Advisors LLC, the New York asset management firm. At Schonfeld, Philip was the lead attorney on the formation of nine private investment funds and created and maintained the compliance program at three investment advisers. He has led the organization of private funds in the US, Cayman and Bermuda. As a consultant, he has served household name hedge funds, PE funds, VCs and investment banks on regulatory and legal matters. Philip is a decorated former US Navy officer. He is a graduate of the US Navy Supply Corps School; a 1995 graduate of Rutgers School of LawCamden; and received an AB from Hamilton College, with honors, in 1992. He is a member of the New York Bar. James Peter Tunkey is Chief Operating Officer of I-OnAsia, a global investigations and security consultancy headquartered in Hong Kong. James and his firm specialize in the conduct of due diligence on behalf of manufacturers and financial investors, including Tier 1 financial institutions, pension, hedge, and private equity funds. Using law enforcement investigation and advanced intelligence gathering techniques to collect information on the backgrounds and activities of key principals, James also supports firms recover from fraud and mismanagement. James is the volunteer Regional Director of the PRMIA New York chapter and former RD of PRMIA's Hong Kong chapter. His PRMIA blog on risk is found at www.prmia.org/Weblogs/General/James_Tunkey. James serves on the boards of the International Council for the Life Sciences and the World Water Center. He is a member of the Council on Foreign Relations and the International Institute for Strategic Studies, amongst other organizations.

Hedge Funds and Fraud: The Future of Due Diligence

Appendix: Presenter Profiles

Gregory M. Ivancich is Chief Operating Officer/Managing Director at Global Risk Management Advisors Inc. He has over 17 years experience in investment management advisory. He was most recently Executive Director in the Investment Banking Division of Morgan Stanley where he advised Morgan Stanley Real Estate on private and public real estate investment strategies, as well as advising numerous third party clients, including REITs, private equity firms and hedge funds on transactions totaling in excess of $10 billion. Prior to Morgan Stanley, Mr. Ivancich was at Credit Suisse (previously Donaldson, Lufkin & Jenrette) where he also advised private and public companies in the real estate sector and was involved with launching the firms private fund raising business, where he was responsible for performing due diligence on new fund manager clients for the firm. While at Credit Suisse, Mr. Ivancich also served as the Chief Operating Officer of the Real Estate Investment Banking Group. Mr. Ivancich began his career at Kidder, Peabody & Co. where he was involved in groundbreaking transactions for public REITs and early commercial mortgage securitizations. He was also involved with assignments for the Resolution Trust Corporation including bulk asset sales and restructurings. He has a Bachelor of Science in Foreign Service from Georgetown University and an MBA from Harvard Business School. He is a member of the National Association of Real Estate Investment Trusts, the International Center for Shopping Centers and is on the board of advisors for MetRock Capital Group. Samuel K. Won is Founder/Managing Director at Global Risk Management Advisors Inc. He has over twenty years of risk management experience at major financial institutions in both the private sector (buy side and sell side) and the public sector, Mr. Won was Chief Risk Officer and Managing Director for Brencourt Advisors, LLC. He was responsible for overseeing investment risk management, risk architecture and analysis, hedging, quantitative portfolio strategies and for playing key roles in asset allocation, new product development and investor relations. Before joining Brencourt, Mr. Won was Chief Risk Officer for Ospraie Management, LLC, where he oversaw investment risk management for over $8 billion in hedge funds and private equity funds. Prior to Ospraie, Mr. Won served as Director of Investment Risk Management for Citigroup Alternative Investments, where he oversaw market, credit and operational risk management for the multi-strategy hedge funds, private equity funds and real estate investment funds for Citigroups $44 billion global alternative investment business. Before moving to the buy-side at Citigroup, Mr. Won was Director of Global Equity Risk Management for Citigroup Global Markets. He was directly responsible for global market risk management for customer and proprietary equity trading and equity capital markets for Citigroups investment bank. Mr. Won served in several posts in the public sector. He was the Risk Manager at the Federal Home Loan Bank Board, where he was responsible for risk management, capital markets and mergers/acquisitions for the bail-out of the savings and loan industry. In addition, Mr. Won served as a Senior Risk Management Adviser to the Resolution Trust Corporation and as a Senior Negotiator at Fannie Mae. Mr. Won has also held senior positions working in risk management, corporate finance, mergers/acquisitions and strategic planning at various major financial institutions including: Dresdner Kleinwort Benson, Goldman Sachs & Company, Bear, Stearns & Company and Great Western Financial Corporation. Mr. Won is on the Executive Steering Committee for the Chief Risk Officers Group at the Managed Funds Association. Mr. Won played a leading role in developing and writing the MFAs Sound Practices Guidelines for Risk Management for the hedge fund industry. He is a member of the Global Association of Risk Professionals and of the Professional Risk Managers International Association. He is a frequent speaker at major investment conferences and has advised regulatory agencies, such as the SEC, the Federal Reserve Bank, the Office of the Comptroller and the FSA on major risk management issues and policies. Mr. Won completed a BA at Northwestern University, attended the Tuck School of Business at Dartmouth College and received a Masters degree from Columbia University with a concentration in International Finance and Economic Policy Management.
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