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Service Providers: The Importance of Prime Broker Due Diligence


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

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Service Providers: The Importance of Prime Broker Due Diligence

  1. 1. Service Providers: The Importance of Prime BrokerDue DiligenceA recent Corgentum study has demonstrated that in the post-Lehman environment investors haveincreasingly and somewhat dangerously downgraded the roles of prime brokers. The majority ofthose surveyed ranked fund administrators and auditors as being more important than primebrokers. Specifically, only 17% of those investors surveyed indicated that they felt that prime brokerswere the most important hedge fund service provider.When investors perform operational due diligence on fund managers, such as hedge funds,evaluating the fund and firm service providers is a critical element of the process. Included in this listof service providers should be a funds prime brokerage relationships.This survey data suggests a trend whereby investors are increasingly minimizing the roles of primebrokers. As a result of this minimized importance, resource limited investors run the very real risk offocusing their due diligence efforts away from prime brokers, and instead on other service providerswhich they view as being more important. As the failure of Lehman brothers has demonstrated,investors can not solely rely on the fact that a prime broker is a big name bank or a leader in theindustry.Additionally, different fund managers may be receiving different levels of services from primebrokers. Without delving into the specifics of such relationships, during the due diligence processinvestors may not have the information they need to make an effective determination as to theservice provider risks to the hedge funds.Operational due diligence on prime brokers also provides investors with a useful avenue forindependent fund manager asset verification. Investors who do not even attempt to contact primebrokers, or who are only confirming a fund manager’s relationships with a prime broker and doingnothing more, are missing this valuable opportunity.For those investors that wisely perform evaluations of fund manager prime brokerage relationshipsduring the operational due diligence process, a word of caution is necessary. Perhaps taking a cuefrom the audit industry and on the advice of their legal departments, prime brokers have becomeincreasingly difficult to deal with.So for example, if an investor reaches out to a prime broker to ask certain questions regarding thenature of their relationship with a fund manager, many times prime brokers will send back genericresponses that do not address the investor’s questions in detail. Furthermore, such responses areoften 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 theirspecific questions answered. In many cases, prime brokers may be unresponsive or slow to respondwhich can
  2. 2. elongate the due diligence process and make it more difficult. However, just because it may bedifficult does not mean that investors are not up to the challenge.By acknowledging the importance played by prime brokers, and constructing a detailed serviceprovider review program which encompasses the specifics of prime brokerage relationships,investors will develop more comprehensive operational due diligence solutions, and perhaps avoidindirect exposure to the next Lehman.Originally posted in the August 2012 edition of Corgentum Consultings Operational Due DiligenceInsights.For More info@corgentum.comInformation | Blog | Twitter Feed Tel. 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 industrys most comprehensive operational duediligence reviews. Corgentums work covers all fund strategies globally including hedge funds, privateequity, real estate funds, and traditional funds. The firms sole focus on operational due diligence,veteran experience, innovative original research and fundamental bottom up approach to duediligence allows Corgentum to ensure that the firms clients avoid unnecessary operational risks. ©2012 Corgentum Consulting, LLC