Operational Due Diligence Insights - Corgentum Consulting's Newsletter


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The August 2012 edition of Corgentum Consulting's Operational Due Diligence Insights newsletter.

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Operational Due Diligence Insights - Corgentum Consulting's Newsletter

  1. 1. August 2012Operational Due Diligence Insights In This Issue Welcome to Our Summer Issue- Regulatory Focus: Singapore’s Failed Attempt at Hedge Fund Regulation Welcome to the summer issue of Corgentum Consultings Operational Due Diligence Insights. This newsletter serves as a resource for news, opinions- Business Continuity Corner: Is the and insights focused on issues related to operational risk and operationalCloud a Viable Hedge Fund BCP/DR due diligence on fund managers including hedge funds, private equity fundsSolution? and traditional managers.- Private Equity: LP’s Are UtilizingOperational Due Diligence to MakeTheir Voices Heard Singapore’s Failed Attempt at- IT Hub: Does Your Hedge Fund’sHardware Matter? Hedge Fund Regulation- Service Providers: The Importance of Recently Singapore announced a major change in its approach to hedge fundPrime Brokerage Due Diligence regulation - and the hedge fund community celebrated.-Term of the Month: Shadow Equity Previously in Singapore hedge funds were not required to be licensed as long as they were classified as exempt fund managers. As long as they only- Fraud Spotlight – Another Day, marketed themselves to so-called qualified investors and met some other basicAnother Hedge Fund Fraud In NJ criteria, there wasnt much oversight or regulation of their activities. All hedge fund managers had to do was provide notification to the Monetary Authority- The Importance of Understanding of Singapore ("MAS") of their choice as to whether to be licensed or not - andFATCA most chose the latter.- On the Calendar ...continued on next page www.Corgentum.com
  2. 2. 2 | Operational Due Diligence InsightsRegulatory - Continued from page 1... 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 millionThis fast and loose approach to hedge fund regulation does not outweigh the burden and costs of hiring awas originally utilized as a marketing tool to lure fund third-party custodian placed on smaller fund managersmanagers to Singapore, and as a 2010 Bloomberg article in the mind of the MSA, however such considerationsstated, "put the city back on the map" as an Asian hedge would likely hold little recompense for the investorsfund destination. who could lose capital in such a situation.For the past two years, the MAS has been studying ways Requirements for independent valuation of investorto increase regulation of hedge funds. After two years assetsof study, and seemingly taking cues from the U.S.sDodd-Frank legislation and recent SEC registration "Independent" is a vague term at best. Does this meanrequirements, the MAS decided to effectively require all that a hedge fund that trades highly liquid positionshedge fund managers above S$250 million to register. such as equities, and is able to price such positions fromSpecifically, under the Securities and Futures (Licensing a third-party source such as Bloomberg, has satisfiedand Conduct of Business) (Amendment No 2) this requirement? Or instead is the work of a third-partyRegulations (2012), hedge funds will now be classified firm engaged by the hedge fund manager, such as ainto two different categories: Fund Management fund administrator, required? Does this mean that it isCompanies ("FMC") and Registered Fund Management now a violation of the Singapore regulations for FCMsCompanies ("RFMC") . RFMC replaces the old Exempt to self-administer?Fund Manager ("EFM") classification.RFMCs can serve up to 30 qualified investors and What about situations where positions are thinly tradedmanage up to $250 million in Singapore dollars, or initially manager marked? Would the hedge fund(commonly written as S$). RFMCs do not need a license manager hiring a third-party administrator, who maybut FMCs will need a license. not have the competency to independently price such thinly traded positions, still satisfy this requirement?According to the MAS press release regarding thesenew regulations, FMCs will subject to "enhanced An overarching concern relating to the use of suchbusiness conduct and capital requirements. These third-party administrators is that administratorsinclude rules requiring independent custody and themselves are hired by the fund managers. While theyvaluation of investor assets, as well as requirements for work for the fund, there are legitimate questions aboutFMCs to undergo independent annual audits by external the true independence of such relationships.auditors and having an adequate risk managementframework commensurate with the type and size of Requirement for FCMs to undergo independent annualinvestments managed by the FMCs." audit by external advisorsLet us analyze each of these items individually: Would this requirement be satisfied by a hedge fund manager’s regular annual financial statement auditRequirements for independent custody – Does this "new" requirement mean that it was previously fine for a manager not to be audited?Does anyone remember Bernard Madoff? The potentialfor manipulation in self-custody relationships is too Once again, it seems the MSA is finally catching up togreat. While it is commendable that the Singapore what is common sense to investors. While investorsfinancial regulators now require independent custody should in no way outsource their operational duefor FCMs- investors should avoid self-custodied diligence responsibilities to a third-party auditor, themanagers, such relationships are generally not worth work of an auditor and the subsequent financialthe potential risk to investors. …continued on next pageCorgentum Consulting ©2012 Corgentum Consulting, LLC
  3. 3. August 2012 | 3Regulatory - Continued from page 2... has unfortunately stopped short in its attempts to implement real oversight and reform. By setting artificially low limits for hedge fund transparency andstatements are extremely valuable to investors during independence, the MSA has demonstrated that it is stilldue diligence. If a hedge fund manager is not audited - partially a captured regulator in the shadow of theinvestors should move on. hedge fund industry it seeks to regulate.If on the other hand the "independent annual audit" One of the more concerning themes of the recent MSAlanguage does not imply that a financial statement reforms is the shifting of the onus towards hedge fundsaudit will not encompass the "independent annual themselves. It is up to hedge funds to ensure adequateaudit" language of the MSA, will FCM hedge funds now risk management procedures are in place and thatbe required to have a separate audit performed in assets are independently valued. Yet, the MSA stopsaddition to the financial statement audit? short of saying how it will police these items.Requirement to have an adequate risk management Effectively, the MSA is hoping the largest hedge fundsframework commensurate with the type and size of play by the rules and will likely utilize these newinvestments managed by the FMCs regulations as a fee generation tool to issue technical fines. Unfortunately, pomp and circumstance seem toOnce again, this is perhaps so vague as to be useless. have won the day, and little actual ongoing oversightMany logical well-intentioned hedge funds may take will be performed. With this new regulation the MSAdifferent approaches, some less conservative than has asked investors to shoulder the burden of hedgeothers, in regards to the definition of the word fund oversight and due diligence.“adequate”. Certainly, it would be considered adequateto have an independent dedicated risk manager, but While the recent MSA reforms are a step in the rightother fund managers may feel that non-dedicated direction, it is unfortunate that meaningful hedge fundoversight is sufficient. How will the MSA regulate this? regulation has yet to come to Asia. Hopefully, it will not take an Asian Madoff to sound the alarm and causeConclusion: regulators to take meaningful action.On the surface investors’ initial reactions to suchenhanced regulatory reforms may be that moreregulation is better for investors. However, it isimportant that investors take measures to not onlyunderstand the technical requirements of newregulatory requirements but also whether these Is the Cloud aadditional requirements will be effective. Viable Hedge FundSingapore has grown as an Asian hedge fund center inthe past few years and is increasingly nipping at the BCP/DR Solution?heels of Hong Kong for hedge fund business.Additionally, despite recent efforts to create a more Cloud computing based information technology andhospitable environment for hedge funds in other Asian business continuity and disaster recovery ("BCP/DR")countries, scandals such as the AIJ fraud in Japan and solutions have becoming increasingly popular in recentcontinued concerns related to fraud in mainland China, years among the hedge fund and private equitycontinue to push Singapore to the forefront ahead of communities. Indeed, many investors seeking toother Asian jurisdictions. perform operational due diligence on fund managers may have come across more and more funds utilizingIn the case of recent MSA measures to further regulate the cloud as of late.the domestic Singapore hedge fund industry, the MSA …continued on next page www.Corgentum.com
  4. 4. 4 | Operational Due Diligence InsightsBusiness Continuity- Continued from page 3... design than an individual fund manager’s systemIt is important for investors to understand exactly what  Application backup - Fund managers may utilizethe cloud is and both the challenges and opportunities cloud based solutions to serve as a backupit presents to fund managers, particularly in relation to location from which applications could continueBCP/DR. to be run, in the event of a business disruption or disaster type event. The continuedWhat is the cloud? operation of applications during such an event may be particularly critical for quantitative orIn the context of evaluating fund BCP/DR high-frequency trading strategies.infrastructures, the cloud can effectively be thought ofby investors as an internet based offsite solution. What should investors ask their fund managers aboutThere are three types of cloud computing, all of which the cloud?are typically classified with the ending, "as a service."They are: The cloud presents a number of attractive benefits to fund managers. As part of an evaluation of a hedge  Platform as a service ("PaaS") - under this funds BCP/DR planning, investors should take the time model service providers provide a computing to understand how their fund managers may make use platform solution to funds such as an operating of such technologies. Some key issues investors may system or web server. want to consider addressing include:  Software as a service("SaaS") - this model  What measures has the hedge fund taken to allows funds to run and access applications on evaluate the BCP/DR planning procedures of cloud based servers. the cloud provider?  Infrastructure as a service ("IaaS") - under this  How does the hedge fund monitor the testing model service providers offer funds access to and oversight of the BCP/DR plan at this virtual machines, storage space and data provider? centers via the internet.  What measures has a hedge fund taken toHow do fund managers utilize the cloud for BCP/DR address security concerns related to storingplanning? data and running applications at third-parties?Hedge funds and private equity funds are increasinglyincorporating cloud based components into their  Does the fund manager incorporate testing ofBCP/DR plans in several ways: access to cloud based data and applications as part of its own BCP/DR tests?  Data storage - increasingly it is cost effective for firms to archive data offsite on cloud based  Has the fund evaluated the cost benefit analysis servers. This reduces expenditures on new of utilized cloud based technologies versus servers and frees up office space for other bringing such technologies in house? At what equipment and personnel point would any cloud benefits be outweighed by internal cost considerations?  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 …continued on next pageCorgentum Consulting ©2012 Corgentum Consulting, LLC
  5. 5. August 2012 | 5Business Continuity- Continued from page 4... 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 dueWhile the increased use of the cloud may be the hottest diligence on the GP. After the review, the LP has a list oftrend among hedge funds for BCP/DR data storage and several operational deficiencies and areas in which theapplication development. Investors should take care to LP feels compared to their peers the GP could improve.understand if a hedge fund has carefully evaluated theiruse of this new technology, or if they are simply Continuing our example, let us assume that from thejumping on the bandwagon. 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 onPE LP’s Are Utilizing these matters. At a minimum, the LP feels it is important to make the GP aware of these issues.Operational Due 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 thisDiligence to Make feedback. This includes performing ongoing operational due diligence to both monitor process improvements,Their Voices Heard as well as to detect any new operational risks. Clinging to their old ways, however, many GPs arent frankly interested in this ongoing LP operational dueIncreasingly, private equity investors, commonly diligence process or receiving any such feedback fromreferred to as Limited Partners or LPs, are performing LPs that have already committed capital. To facilitateoperational due diligence prior to allocating to private this lack of dialogue, GPs utilize a structure wherebyequity funds. It is good to see that LPs have taken cues they have so-called advisory boards upon whichfrom their hedge fund counterparts, and areincreasingly recognizing that private equity funds typically sit the largest investors in a particular fund. Aspresent just as many, if not more, operational risks to such, smaller LPs effectively become squeezed out ofinvestors as compared to hedge funds. the process. More LPs are beginning to realize the flaws in such arrangements and have decided to becomeUnfortunately, private equity fund managers, proactive not only in their due diligence efforts, but incommonly referred to as General Partners or GPs, have engaging with GPs in more frequent dialoguesbeen slower than their hedge fund portfolio manager concerning both investment and operational issues.counterparts in listening to LP feedback. This is to beexpected as GPs have long capitalized on the long-term A program of initial and ongoing operational duenature of private equity investing to insulate themselvesfrom frequent interaction with LPs. diligence for private equity can help ensure that an LP detects operational issues before committing capital,In the past, after an LP committed capital, there were and is alerted to any new potential problems beforelittle if any updates from GPs outside of prescheduled they spin out of control. As this trend continues, LPsupdates, generally quarterly, on portfolio performance. that do not engage in such programs may increasinglySuch an arrangement has effectively robbed LPs of their find themselves to be the exception rather than thevoice as partners in the investing process. More LPs norm.have come to acknowledge this fact, and areincreasingly pro-actively sharing feedback with GPsafter the initial and ongoing operational due diligenceprocesses. www.Corgentum.com
  6. 6. 6 | Operational Due Diligence InsightsDoes Your Hedge Often times the equipment utilized in both internal hardware and external hardware situations is similar. Common types of information technology hardware andFund’s Hardware peripherals, includes desktop computers, routers and servers. In addition to this standard equipment, many fund managers may also have additional hardware,Matter? which provides backup power generation capabilities, such as generators or UPS devices. It is worth noting that each of these types of equipmentWhen performing operational due diligence, investors is a broad umbrella term, which encompasses a wideevaluating a hedge fund’s information technology variety of meanings. So for example, a fund managerinfrastructure have a tendency to focus intently on could have several different types of servers (i.e. -software applications. Software is email/ Exchangecrucial to a fund managers server, SQL server,operations. Evaluating the ways in Blackberry sever etc.).which software interacts with It is important forother functions can provide critical investors toinsight into the operational understand theinfrastructure of a fund. But what different types ofabout hardware? Isnt all hardware equipment in eachcreated equal? category so that they can effectivelyWhat kind of hardware are we evaluate the overalltalking about? information technology function.First of all, in evaluating a fundmanagers hardware it is Investors should takeimportant to clarify what exactly stock of a managerswe are talking about. Fund managers effectively hardware inventory when reviewing the informationinteract with hardware in one of two ways. The first is technology function during the operational duethat they purchase or lease hardware that is under their diligence process. With this inventory map in place,control. We can classify this type of hardware as investors will have a roadmap by which they caninternal hardware. navigate and evaluate the hardware review process.The second type of hardware is not owned by the hedge Do brand names matter?fund but by a third-party, and is where a fundmanagers data is stored or passes through in the case After an investor has developed an understanding ofof trading platforms. We can classify this type of the types of hardware utilized by a fund manager, it ishardware as external hardware. One of the more recent also important for investors to learn of the brand namesexamples of the ways in which fund managers interact of the manufacturers of such hardware. Certain types ofwith external hardware is the increased use among fund hardware are considered to be of higher quality thanmanagers of colocation solutions, cloud computing and others. Additionally, different types of hardware fromcloud based storage solutions. In these cases, managers different manufacturers may have different capabilities.are often utilizing large third-party servers on which By inquiring not only as to the types of hardware inthey have space allocated to them. It is important for place, but also as to the brand names of theinvestors to understand the distinction between manufacturers of such hardwareinternal hardware and external hardware in order toeffectively evaluate a fund managers hardware …continued on next pageinfrastructure.Corgentum Consulting ©2012 Corgentum Consulting, LLC
  7. 7. August 2012 | 7Hardware - Continued from page 6... Evaluating a funds hardware infrastructure can provide valuable insights beyond just the specifics of the hardware. By asking more detailed questions during the(in conjunction with evaluating hardware capabilities), operational due diligence process investors can gleaninvestors may be able to make more fully informed information as to how the firm approaches otherdecisions when evaluating the overall strength of the operational issues, such as business planning andinformation technology function. scalability as well.How much is enough? Returning to our question of how much storage space is enough - there is no definitive answer. Each fundDuring the operational due diligence process investors managers situation will be different. However,will often take a tour of a fund managers information investors should ask themselves if during the duetechnology closet. This room is often loud (due to the diligence process they are asking the fund managerbuzzing of cooling fans), and cold (so that the questions such as:equipment does not overheat). When many investorswalk into these rooms they often see large columns of  How do you evaluate how much storage spaceequipment in racks with numerous flashing lights and you need?wires running between them.  How much space do you currently have?Many investors may not be able to distinguish betweendifferent types of hardware, because they may not beaware of what these different pieces of hardware  Have you taken measures to plan ahead so thatactually look like. Putting this aside, investors seeking to the firms storage architecture is scalable?evaluate the strength and scalability of a fundmanagers information technology function may also be By digging deeper into the hardware evaluation processunable to answer a more basic question - how much during operational due diligence on informationhardware is enough? technology, investors will not only have a much more detailed picture of a fund managers overall informationThis question is perhaps most easily thought of in terms technology framework, but also a better understandingof data storage space. Consider the following two fund on how those in charge organize their business.managers: Fund Manager A is a small fund managerwho has five employees and has been in business forthree years. Fund Manager B is a larger firm with 35 Service Providers: Theemployees and has been in business for eight years.Which Fund Manager is likely to need more data Importance of Prime Broker Due Diligencestorage space?The answer is obvious when such a stark comparisonamong organizations is in place. Although it is clear thatFund Manager B would require more data storagespace, the next logical question is - how much is A recent Corgentum study has demonstrated that in the post-Lehman environment investors have increasinglyenough? and somewhat dangerously downgraded the roles of prime brokers. The majority of those surveyed rankedConsider a prospective investor who is considering fund administrators and auditors as being moremaking an allocation to Fund Manager A. During theoperational due diligence process, they take the tour of important than prime brokers. Specifically, only 17% ofthe aforementioned standard clean, cold and loud those investors surveyed indicated that they felt thatserver closet. To most investors, unfortunately, ifeverything looks and sounds good this is where theystop their hardware due diligence. …continued on next page www.Corgentum.com
  8. 8. 8 | Operational Due Diligence InsightsPrime Brokers - Continued from page 7... and on the advice of their legal departments, prime brokers have become increasingly difficult to deal with.prime brokers were the most important hedge fund So for example, if an investor reaches out to a primeservice provider. broker to ask certain questions regarding the nature of their relationship with a fund manager, many timesWhen investors perform operational due diligence on prime brokers will send back generic responses that dofund managers, such as hedge funds, evaluating the not address the investor’s questions in detail.fund and firm service providers is a critical element of Furthermore, such responses are often rife with legalthe process. Included in this list of service providers disclaimer language making them difficult to evaluate inshould be a funds prime brokerage relationships. certain circumstances. The onus is then put back on investors to follow up with the prime brokers toThis survey data suggests a trend whereby investors are attempt to have their specific questions answered. Inincreasingly minimizing the roles of prime brokers. As a many cases, prime brokers may be unresponsive orresult of this minimized importance, resource limited slow to respond which can elongate the due diligenceinvestors run the very real risk of focusing their due process and make it more difficult. However, justdiligence efforts away from prime brokers, and instead because it may be difficult does not mean that investorson other service providers which they view as being are not up to the challenge.more important. As the failure of Lehman brothers hasdemonstrated, investors can not solely rely on the fact By acknowledging the importance played by primethat a prime broker is a big name bank or a leader in the brokers, and constructing a detailed service providerindustry. review program which encompasses the specifics of prime brokerage relationships, investors will developAdditionally, different fund managers may be receiving more comprehensive operational due diligencedifferent levels of services from prime brokers. Without solutions, and perhaps avoid indirect exposure to thedelving into the specifics of such relationships, during next Lehman.the due diligence process investors may not have theinformation they need to makean effective determination as tothe service provider risks to the Understanding Fundhedge funds. Terms: Shadow EquityOperational due diligence onprime brokers also providesinvestors with a useful avenuefor independent fund manager Operational due diligence is a multidisciplinary subject.asset verification. Investors who An investor beginning the operational due diligencedo not even attempt to contact process for the first time may encounter subjects withprime brokers, or who are only which they have little to no familiarity. As the scope ofconfirming a fund manager’s operational due diligence has become broadened inrelationships with a prime broker recent years, even seasoned operational due diligenceand doing nothing more, are professionals may encounter terms which they may bemissing this valuable unfamiliar. The purpose of this section of Operationalopportunity. Due Diligence Insights is to cast a spotlight on some of the words and terms which investors may have notFor those investors that wisely perform evaluations of previously encountered, or which tend to getfund manager prime brokerage relationships during the overlooked in operational due diligence reviews.operational due diligence process, a word of caution isnecessary. Perhaps taking a cue from the audit industry …continued on next pageCorgentum Consulting ©2012 Corgentum Consulting, LLC
  9. 9. August 2012 | 9Shadow Equity- Continued from page 8...This issues word: FraudShadow Equity (also known as Phantom Equity) Spotlight:Defined: AnotherShadow equity refers to a type of compensation schemefor hedge fund investment professionals. Employees Day, Another Hedgecompensated via a shadow equity scheme are notcompensated as if they were direct owners of the hedge Fund Fraud in NJfund (i.e. - General Partner), but are effectively treatedas investors of the fund. According to authorities, another classic Ponzi schemeWhat investors should know: has hit the state of NJ.The way in which a fund manager compensates its Daniel Dragon of Lebanon, NJ and Carmelo Provenzanoemployees can provide useful insights into how it values of Garfield, NJ have pleaded guilty to wire fraud in aand retains its professionals. Shadow equity schemes Camden, NJ courtroom. This guilty plea comes on theare compensation schemes that seek to align the heels of accusations of fraud against a Jersey City, Newinterest of personnel with those of investors. The Jersey based fund and Osiris Partners.theory is that this so-called skin in the game helps togenerate harder working investment professionals who In this case, Dragon and Provenzano told investors that:will act in the best interest of investors. Employeecompensation schemes can also contain vesting  The firm had created a proprietary black boxcomponents which facilitate the retention of employees computer algorithm that had produced returnsthrough financial incentives for remaining at a firm. of 170% from 2009 to July 2011 in the FX markets.During the operational due diligence process investorsshould analyze not only the management and  Investors could get their money back at anyperformance fees generated by a fund manager, but time with only one day’s notice.also the ways in which these fees are distributed toemployees via internal compensation structures, such When some investors started asking questions the duoas shadow equity. Funds that have carefully structured emailed investors screenshot of fictitious investoremployee compensation to incentivize employees and account statement from a completely made up investorretain talent often have lower turnover. 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. www.Corgentum.com
  10. 10. 10 | Operational Due Diligence InsightsThe Importance of The US is seeking to work in cooperation with international governments to enforce FATCA. In 2012, the US Treasury and the IRS released a statementUnderstanding FATCA 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 internationalThe Foreign Accounting Tax Compliance Act ("FATCA") is tax authorities and then the IRS would step in toa 2010 US tax law which has implications for both hedge collaborate.fund managers and investors. Tax is an area thatunfortunately causes many investors eyes to glaze over Although FATCA was signed into law in 2010, it does notduring the operational due diligence process. The goal technically take effect until January 1, 2013.of analyzing tax structures during due diligence is not to Withholding for FATCA, what in IRS speak is known asnecessarily develop a formal tax opinion as would be so-called fixed or determinable annual or periodicalreceived from an investors tax advisers (i.e. - tax payments or FDAP, will not begin until January 1, 2014.counsel or accountant) but rather to gain a betterunderstanding of whether a hedge funds trading How do hedge funds and private equity funds complyactivities could potentially generate negative tax with FATCA?consequences for its investors. Examples of commontax hedge fund and private In order to comply with FATCA, fundequity tax issues which can fall managers must provide US Internalinto this classification include an Revenue Service ("IRS") withanalysis of whether or not a fund documentation on its investors.may have generated or Specifically, those investors that haveanticipates generating unrelated more than $50,000 invested outside ofbusiness taxable income or the US. Similar to anti-moneyeffectively connected income, laundering documentation, thesemore commonly referred to as documents include certain clientUBTI and ECI. balances, receipts, withdrawals and account identification numbers.Furthermore, as with most thingsrelated to operational due diligence, the way in which a Why do investors need to understand FATCA?hedge fund manager approaches detailed issues such astax structuring can provide valuable operational insights Although FATCA will not take effect until 2014, thereinto the ways in which it approaches its larger business are a number of reasons why investors need to inquireinfrastructure. now about their fund managers plan to comply with FATCA. The penalties for non-compliance are steep. If aWhat is FATCA? fund manager violates FATCA, they will be penalized by a 30% withholding tax being placed upon the foreignFATCA, was formally enacted in March 18, 2010 with financial institution’s US assets or sourced income. Thisthe goal of preventing US citizens from tax evasion is a materially negative consequence and could havethrough hiding income or assets abroad in foreign large negative implications for both investors and thebusinesses. FATCA applies to many different types of fund.firms including hedge funds and private equity fundsboth within the US and international. FATCA technically Additionally, because FATCA is effectively a US taxclassifies these non-US fund managers, sometimes regulation which has international implications, therereferred to as passive foreign investment companies or are privacy concerns raised.PFIC in IRS jargon, as so-called Foreign FinancialInstitutions or FFIs. …continued on next pageCorgentum Consulting ©2012 Corgentum Consulting, LLC
  11. 11. August 2012 | 11FATCA- Continued from page 10... (iv) Classify investors into FATCA groups and ensure FATCA compliant documentation on each investor is maintainedFor instance a hedge fund may be required underFATCA to make FATCA related disclosures to the During the operational due diligence process investorsCanadian regulators. Under Canadian privacy it is should take measures to effectively vet the approachunclear whether such disclosures may be their fund managers take to FATCA before the IRSmandated or voluntary in nature. Furthermore, a hedge shows up at their door.fund manager which makes such disclosures may besubjected to potential liability for violating privacyconcerns.Investors can often obtain some guidance in regards tohow their hedge funds and private equity fundsapproach FATCA by asking their fund managers howthey plan to develop a plan to comply with FATCA.Typically, most fund managers seeking to develop aplan to comply with FATCA will work with externalaccountants and legal counsel to address this issue.Some key questions investors can ask to gauge if a fundmanager has thought about FATCA and has developed aplan for compliance include:  Does the fund manager, or operations personnel, understand what FATCA is?  Do they understand the timeline by which they need to comply?  Has the fund spoken to their accountants and lawyers about FATCA?  What advice did they give the fund?  Has the fund begun to think of the specific details of FATCA compliance including: (i) Identifying so-called "Responsible Officers" who must certify FATCA compliance (ii) Developing a plan for fund offering memorandum and subscription documents with FATCA disclaimers (iii) Analyze internal AML/KYC procedures as well as the work with the funds administrator to ensure AML/KYC procedures will be appropriately in compliance with FATCA www.Corgentum.com
  12. 12. 12 | Operational Due Diligence InsightsOn the CalendarPlease see below for a list of upcoming operational risk items of note and events:  Opal Investment Trends Summit (Santa Barbara, CA) September 12-14, 2012. Jason Scharfman to moderate Private Equity panel Presented by Opal Financial Group.  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.  Opal Endowment & Foundation Forum (Boston, MA) November 12-14, 2012. Corgentum speaking on Consultants panel Presented by Opal Financial Group. About Corgentum Consulting Corgentum Consulting is a specialist consulting firm which performs operational due diligence reviews of fund managers. We work with investors including fund of funds, pensions, endowments, banks and family offices to conduct the industrys most comprehensive operational due diligence reviews. Our work covers all fund managers and strategies globally including hedge funds, private equity, real estate funds and traditional funds. Our sole focus on operational due diligence, veteran experience, innovative original research and fundamental bottom up approach to due diligence allows us to ensure that our clients avoid unnecessary operational risks. More information is available at www.Corgentum.com or follow us on Twitter @Corgentum. Email: Info@Corgentum.com Main Tel. 201-918-520 Corgentum Consulting ©2012 Corgentum Consulting, LLC