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New Regulatory Burdens Placed on InvestorsThe area of fund compliance has been in flux over the past few months. Spurred i...
An investor performing operational due diligence, who did not inquire as to the identity of a fundsauditor would not reall...
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Hedge fund operational_due_diligence_corgentum_insights_regulatory_burden_


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Originally posted in the May 2012 edition of Corgentum Consulting's Operational Due Diligence Insights.

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Hedge fund operational_due_diligence_corgentum_insights_regulatory_burden_

  1. 1. New Regulatory Burdens Placed on InvestorsThe area of fund compliance has been in flux over the past few months. Spurred in part a number offactors including the continuing financial crisis and the passage of new laws such as Dodd-Frank, theUS financial regulatory system has seen the enactment of new registration requirements for manyfund managers, including hedge funds and private equity funds. As more and more funds haveadded their names to the regulatory registration rolls, so too have funds now been required torelease more information than ever before. Outside of the US, similar demands for increased fundregistration are being echoed in Europe via initiatives such as MiFiD, and in Asia via increasedregulatory oversight in countries such as Singapore.Fund managers and their lobbying groups originally resisted against such additional registration anddisclosure requirements. The unfortunate result for investors seems to be a regulatory compromisewhich relies seems to rely more on the volume of actual disclosures rather than how meaningful theyare. This all show and less substance regulatory format runs the risk of fueling an already vulnerableinvestor base which may be increasingly seeking to cut corners on unwisely operational duediligence. A good example of how this works in practice relates to enhanced ADV disclosures whichUS SEC registered fund managers must now make. Specifically, in the US, fund managers registeredwith the SEC are now required to disclose several pieces of information which were not previouslymandatory. Currently, for SEC registered funds, many of these disclosures come on Form ADV andpotentially in the future via additional forms such as the new Form PF.There is really nothing that new about the additional Form ADV disclosures, as they have been inplace for a while. However, as many managers which were previously unregistered now register,many recent articles in the media have focused on the information revealed in this form abouttraditionally very secretive managers. The types of additional information disclosed which were notnecessarily mandated a few years ago includes additional biographical information about the firmand key personnel as well as details about fund service providers. While the general consensusamong the investment community, at least in a due diligence context, is that additional disclosuresand government oversight is a good thing, the hedge fund industry has seemed to pull the wool overinvestors eyes. The nature and types of disclosures allow hedge funds and private equity managersto seemingly be more transparent and perhaps indicate a sense of capitulating to investor andgovernment demands for additional transparency. The problem for investors seeking to perform duediligence however, is that the transparency levels are set so artificially low as to make theseadditional disclosures almost moot in nature.The bulk of the "additional" Form ADV disclosures provide information which is so basic in naturethat any investor performing operational due diligence on a fund manager would be reckless as tonot request it to begin with. For example, in Part B of Section 7.B.1(1) of Schedule D, the currentForm ADV disclosures require fund managers to provide service provider information concerning fivetypes of service providers (auditors, prime brokers, custodians, administrators and marketers) whichthe SEC views as being important so-called "gatekeepers" for private funds. Generally, therequirements are that the fund manager provide the "gatekeepers": 1) identity, 2) location and 3)state whether they are related (i.e. - affiliated) with the fund manager.© 2011 Corgentum Consulting, LLC
  2. 2. An investor performing operational due diligence, who did not inquire as to the identity of a fundsauditor would not really be conducting much operational due diligence at all. Forcing a manager toput these disclosures in writing to the SEC is a positive development, but why did the SEC stop soshort, when they had the ability to force managers to make meaningful disclosures. These limitedscope disclosures runs the dangerous risk of allowing certain investors to believe that they either (byrequiring the enhanced Form ADV disclosures the government) will actually be responsible forpolicing fund managers better or even worse, that investors can solely rely on the government toperform due diligence on fund manager’s operational aspects.With a belief that the more information managers disclose is necessarily better, investors may losesight of the importance of what information is actually disclosed. Phrased another way, is it better toknow 100 pieces of information which may hold little value from an operational risk perspective orfive pieces of information of higher value?With more information comes more responsibility. The onus is on investors, or their advisors, toensure that effective operational due diligence is performed on fund managers. Collecting andreviewing regulatory filings, be it in the US or in other jurisdictions, such as Form ADV (replete withadditional disclosures and all) is certainly something investors should do, but they should becautious not to become overly reliant on regulators to put together a complete operational duediligence review - that is still the job of the investor.Originally posted in the February 2012 edition of Corgentum Consultings OperationalDue Diligence Insights.For More info@corgentum.comInformation | Blog | Twitter FeedTel. 201-360-2430About Corgentum Consulting:Corgentum Consulting is a specialist consulting firm which performs operational due diligencereviews of fund managers. The firm works with investors including fund of funds, pensions,endowments, banks ultra-high net-worth individuals, and family offices to conduct the industrysmost comprehensive operational due diligence reviews. Corgentums work covers all fundstrategies globally including hedge funds, private equity, real estate funds, and traditional funds.The firms sole focus on operational due diligence, veteran experience, innovative originalresearch and fundamental bottom up approach to due diligence allows Corgentum to ensurethat the firms clients avoid unnecessary operational risks. Corgentum is headquartered at 26Journal Square, Suite 1005 in Jersey City, New Jersey, 07306. Phone 201-360-2430. For moreinformation visit, or follow us on Twitter @Corgentum.© 2011 Corgentum Consulting, LLC