Good Risk Governance Pays

Hedge Fund Fees - More Questions

Susan Mangiero — Thu, 03 May 2012 21:56:17 -0500

A financial advisor approached me the other day with a question about whether his endowment client should be expected to pay a management fee on assets that are subject to lock-up and likely to be liquidated.He added "I understand that the 20% fee on any profit wouldn't apply since there are no profits but I cannot imagine that paying a management fee of whatever amount on an asset carried at its purchase price, but likely to be worthless at the end of the lock-out period, would be the act of a prudent fiduciary. But perhaps the endowment would be obliged to pay a fee based on the terms of the contract."

While I don't like to answer questions without having adequate information, my immediate immediate response was to say that a lock-up does not necessarily translate to an asset having little or no value.

Being curious about what others would say, I asked two hedge fund experts, Attorney Tim Selby and Attorney Joyce Heinzerling. They have each given me permission to reproduce their answers herein.

According to Attorney Tim Selby:

It is common practice for a manager to charge a management fee on an illiquid asset. Even though the asset is illiquid, the manager may in fact still be actively managing and monitoring the asset. In private equity funds, the manager will typically reduce the management fee on assets under management once the investment period ends because its activity lessens. This is not, however, a common practice with hedge fund managers who manage an illiquid portion of a fund’s portfolio. Typically they will still charge the full management fee but it will be based on the cost of the investment rather than its fair market value which may not be determinable. Depending on the amount invested by the investor it may be able to negotiate for a reduced fee.

According to Attorney Joyce Heinzerling says:

"Quite ofen a hedge fund manager side-pockets an illiquid investment and when that ocurs, generally speaking, the manager will not typically charge a management fee on the side-pocketed assets. But that is not always the case. I know of several hedge fund managers that continue to charge management fees on side-pocketed assets from back in the 2008-2009 period. That is not a best practice. Ultimately, the fund's Private Placement Memorandum ("PPM") will disclose whether the manager will charge fees on side-pocketed assets. If that language is not included in the PPM, then the manager would have to send a letter to investors stating the intent to charge fees on side-pocketed assets. With that, the hedge fund manager would attest that there is no constituent document language or other legal reasons the prehobits the hedge from manager from proceeding in that direction.
If the financial advisor is asking about the "fund" being in a lock-up period because liquidity is so bad that it cannot honor redemptions (if they are allowed in the first place), the answer to the fee question should be found in the PPM. The standard practice is to continue to charge a management fee because the manager is tending to portfolio investments in order to gain liquidity. You are correct that one cannot make an assumption about the value of an asset just because it is carried at cost. Even if an asset is illiquid, there is bascially a chance that the asset will eventually reset to a higher value. One cannot assume today that any particular asset will have no value at the end of a lock-up period, whether it is in the case of a side-pocket or a suspension of redemptions.
All investors are treated the same in these cases, it would not matter that the investor is a endowment versus a pension plan versus a high net worth individual."

When I recounted these answers to the inquiring financial advisor, his response suggested that such terms would be deemed onerous by his client. A natural reaction is to advise all parties involved to carefully review the terms of any investment, hedge fund or not.

Recent studies suggest that pressure on hedge fund and private equity fund manager to lower fees will continue. No doubt discussions will address redemption, valuation and liquidity as well.

Investment Fraud Early Warning Signs

Susan Mangiero — Sat, 14 Apr 2012 16:08:47 -0500

My comments on April 3 about investment fraud and risk governance struck a chord. As a co-presenter for "Going Beyond the Essential Background Checks: Accessing Crucial Information About the Management Team, Board of Directors, the Economics for the Team and the Succession of the Investment Staff," 4th Annual Due Diligence & On-Going Monitoring of Alternative Investments Summit, Financial Research Associates, LLC, I talked about the numerous reasons why a typical background check is necessary but insufficient.

Send an email to Dr. Susan Mangiero if you would like more information about investment fraud thought leadership under way.

In the meantime, some hot button items that should be considered by institutional investors and asset managers that want to be green lighted by pensions, endowments, foundations, family offices and sovereign wealth funds include, but are not limited to, the following:

Legal Ownership Structure - Ask for information about who owns what, who has voting rights and whether or when assets can be transferred across legal and tax jurisdictions. If an asset manager cannot or will not provide an organization chart and legal documentation that explains an often complex ownership structure, think twice about taking next steps. I resigned from an assigment to value a U.S. hedge fund limited liability partnership ("LLP") when the CEO and the company's attorney begrudgingly provided by-laws and an organization chart that illustrated firsthand a hard-to-understand web of cross-ownership (offshore and onshore). Should trouble occur, it is imperative to understand how economic rights are distributed and on what basis.
Job Descriptions - A titular executive is not the same thing as having an experienced and knowledgeable person fill a critical function. As an expert witness, I wrote a report that pointed out, among other things, that the Chief Risk Officer was in name only. The actual person who bore that title was anything but a risk management professional.
Internal Controls - Entire books have been written about the importance of vetting operational risks and internal controls. Suffice it to say, make sure that important tasks such as trading and approving wire transfers are each carried out by different individuals. Transactions should be verified on a regular basis by independent parties. Checks and balances should be in place to avoid breach for items such as surpassing trade size, making a material change to investment reports and/or modifying the approval process for moving money.
Complexity and Model Risk - As I discussed in "Model Risk and A $242 Million Overlay" (February 3, 2011), models can be nested so that mistakes made at one level can be catastrophic if not caught early and corrected. That is exactly what happened in a matter relating to AXA Rosenberg, costing the firm nearly $250 million. Someone has to kick the tires on a regular basis. Model audits should be conducted by individuals who are not going to be compensated on the basis of a model's outcome(s). When trading strategies are complex, it is sometimes tough to identify problem areas. I remember the words of one of my doctoral professors vividly because they still ring true today. "If you can't explain a trading strategy or make-up of a model, you don't know enough to make important decisions."
Key Person Risk - Marquee name traders may be a draw for institutional and high net worth investors but proceed with caution. First of all, banking on a name trader does not guarantee that good processes are in place. Second, it is critical to know if key person insurance is in place to address the early exit of a trader or executive and the exact nature of the coverage. Also inquire about what happens if a key person gets a divorce and an ownership stake in the asset management firm becomes part of the settlement. Investigate whether the firm has a succession plan, a non-compete contract for departing executives and/or buy-sell agreement to guide how partners leave or join the firm.
Intellectual Property - Ask about ownership of a patent, trademark, proprietary technology and/or marketing/sales collateral. In one situation, there was a real concern that the head of sales would have carte blanche to use the client list on behalf of a competitor. Depending on the costs to acquire each client, use of a list elsewhere could deal a crushing blow to a firm and by extension, destroy value for limited partners and/or investors in a particular fund or fund family.
Governance and Committee Structure - A board of advisors can serve as a line of defense for investors in a fund as long as its members do their job well. I recall being interviewed to serve as an expert for a large hedge fund litigation. After having read the initial documents, I told the attorneys that the existence of a pricing committee and a risk management committee was impressive and asked to see the meeting minutes. The response was that neither committee had ever met. Of course a committee could meet on a regular basis but never address critical issues and thereby be ineffective, offering no safeguard for an investor(s).
Vendor Contracts - Unless someone is doing a comprehensive review of service provider contracts, an investor is likely to encounter a coverage gap. In the matter of hard-to-value investing for example, many times an independent verification of prices is left undone when fund of funds managers, prime brokers, custodian banks and/or consultants accept numbers from hedge fund and private equity funds "as is" as part of their respective contracts.
Investment Reports - Financial statements, audited or otherwise, do not always provide the same information on investment reports. The topic of performance reporting is left for another post as it is both broad and complicated. Suffice it to say however, all investors should be treated equally in terms of information access. With side letters and side pocket arrangements, disclosure may be limited and provided on a selective basis. As an expert on a regulatory enforcement case, I explained what industry standards exist for reporting true economic risks and returns versus statements that may be misleading at best. The hedge fund being investigated had topped off losses for some investors but not others and used some creative ways to report results.
Borrowing Capacity - In 2008 and 2009, numerous investors were taken by surprise when asset managers were unable to honor redemptions (if allowed in the first place). One indicator (and there were many) of a liquidity crisis was the inability for some asset managers to borrow enough cash to keep going. Even worse, some prime brokers pulled back existing credit lines and/or charged considerably more which in turn depressed potential upside for investors. Ask about the current costs of borrowing and the capacity and sources for an asset manager to borrow more if needed. Depending on the leverage inherent in an asset manager's trading strategy, it may be necessary to ask for a copy of borrowing agreements and to understand what could trigger a margin call(s).

The list of problem areas is long and worthy of close scrutiny, ideally by an independent third party who can work with the internal auditor, external auditor and/or board of directors (assuming that all of these parties are focused on best practices and not contributing to a fund's downfall). Institutional and high-net worth investors alike should monitor these and other risk factors before writing a check.

Background checks are invaluable tools for investors who want to conduct proper due diligence. Importantly however, a background check is simply not going to provide the kind of information described above that can make a difference between investment success and failure.

Insider trading, anti-money laundering, investment fraud techniques and much more are left for future blog posts...

ERISA Pension Plans: Due Diligence for Hedge Funds and Private Equity Funds

Susan Mangiero — Mon, 02 Apr 2012 23:53:58 -0500

Join me on May 1, 2012 for a timely and interesting program about alternative investment fund due diligence and other considerations for ERISA plan sponsors, their counsel and consultants. Click here for more information.

This CLE webinar will provide ERISA and asset management counsel with a review of effective due diligence practices by institutional investors. Best practices will be offered to mitigate government scrutiny and suits by plan participants.

Description

With the DOL's and SEC's new disclosure rules and heightened concerns about compliance and valuation, corporate pension plans that invest in alternatives must focus on properly vetting asset managers more than ever before or risk being sued for poor governance and excessive risk-taking.

The urgencies are real. The use of private funds by asset managers is crucial for 401(k) and defined benefit plan decision makers. Understanding the obligations of private funds is essential to any retirement funds with limited partnership interests.

In addition, suits and enforcement actions against asset managers make it incumbent on counsel to hedge fund and private equity fund managers to fully grasp and advise on full compliance with the duties of ERISA fiduciaries to plan participants.

Listen as our ERISA-experienced panel provides a guide to the legal and investment landmines that can destroy portfolio values and expose institutional investors and fund managers to liability risks. The panel will outline best practices for implementing effective due diligence procedures.

Outline

ERISA fiduciary duties for institutional investors

Hedge funds and private equity funds compared to traditional investments

Regulatory developments

Disclosure
Compliance
Valuation

Developments in private litigation involving pension plan fiduciaries and alternative fund managers

Best practices for developing due diligence plans

Benefits

The panel will review these and other key questions:

What are the regulatory concerns for ERISA pension plans that allocate assets to hedge funds and private equity funds?

What are the potential consequences for service providers that fail to comply with new fee, valuation and service provider due diligence regulations?

What can counsel to pension plans and asset managers learn from recent private fund suits relating to collateral, risk-taking, pricing, insider trading and much more?

How should ERISA plans and asset managers prepare to comply with expanded fiduciary standards?

Following the speaker presentations, you'll have an opportunity to get answers to your specific questions during the interactive Q&A.

Faculty

Susan Mangiero, Managing Director
FTI Consulting, New York

She has provided testimony before the ERISA Advisory Council, the OECD and the International Organization of Pension Supervisors as well as offered expert testimony and behind-the-scenes forensic analysis, calculation of damages and rebuttal report commentary for various investment governance, investment performance, fiduciary breach, prudence, risk and valuation matters.

Alexandra Poe, Partner
Reed Smith, New York

She has over 25 years of experience in investment management practice counseling managers of hedge funds, private equity funds, institutional accounts, mutual funds and broker-dealer advised programs. She counsels hedge and private equity fund advisers in all stages of their business and due diligence matters.

Upcoming ERISA Litigation and Compliance Events

Susan Mangiero — Mon, 02 Apr 2012 23:37:54 -0500

I have the pleasure of moderating a series of in-person and telephonic conferences about ERISA litigation and compliance in the next several months. Formally entitled the "FTI Consulting ERISA Litigation and Compliance Breakfast Series 2012: The $17.5 Trillion Challenge For Corporate Executives and Asset Managers," professionals working for or with pension plans are encouraged to attend these no-charge sessions with experts in New York (April 18, 2012), Chicago (April 26, 2012), Boston (May 3, 2012), Washington, DC (May 9, 2012), Philadelphia (May 15, 2012) and San Francisco (June 5, 2012).

The corporate pension market in the United States is facing unprecedented challenges in the form of massive deficits, new disclosure rules, recapitalizations, complex financial arrangements, turbulent market conditions and a rise in fiduciary breach litigation against C-level decision makers, board members and asset managers. Plan sponsors are being asked to improve governance, better manage risks and acknowledge the enterprise impact of nearly $18 trillion invested in U.S. retirement vehicles such as defined benefit plans and 401(k) plans. The perfect storm of low interest rates, sagging equity returns, mandatory cash infusions, increased longevity, financial volatility, investment complexity and greater regulatory scrutiny is a reality that is here to stay. Being informed and action-oriented is important as never before.

Join leading industry and regulatory experts in a lively discussion about the changing legal and financial landscape for ERISA fiduciaries, counsel and asset managers. Aimed at professionals who work for or with corporate benefit plans, these complimentary breakfast meetings examine the impact of new rules and regulations, lessons learned from the courts and ways to mitigate personal and professional liability at a time when fiduciary litigation is soaring.

Join us in New York, Chicago, Boston, Washington, Philadelphia and/or San Francisco for breakfast and a chance to hear and participate in a moderated panel discussion session about important topics such as pension and 401(k) plan governance, service provider due diligence, fee economics, withdrawal liability, successor liability, bankruptcy restructuring and much more. Stay abreast of breaking news, network with colleagues and earn CLE, if applicable. Call-in arrangements will be made for those who cannot attend in person so you can participate in each and every event.

For more information, including a list of esteemed speakers, visit http://www.fticonsulting.com/email/erisa2/.

New Litigation Risks For Retirement Plan Providers

Susan Mangiero — Mon, 19 Mar 2012 19:46:32 -0500

According to Shannon Barrett, attorney and partner in O'Melveny & Myers' ERISA litigation practice, new fee disclosure regulations could mean more lawsuits against record-keepers and other organizations that provide services to U.S retirement plans. Cited in "New Fee-Disclosure Regs Pose New Litigation Risks for Retirement Plan Providers" by Fran Lysiak (Insurance News Net, March 2, 2012), Barrett adds that new rules "will force record-keepers and similar service providers to 'stake a position on something that is a very disputed legal issue,' referring to fiduciary status.

For more information, check out "DOL Retirement Plan Fee and Expense Disclosure Compliance: Navigating New Rules for Service Providers and Plan Sponsors." Sponsored by Strafford Publications, this March 27, 2012 webinar will feature two senior ERISA legal experts with Morgan Lewis, Michael B. Richman and Daniel R. Kleinman, and will explain Section 408(b)(2) disclosure rules and what compliance (or lack thereof) means.

Transparency is a continued mantra with regulators and lawmakers in the United States and elswhere. In a recent conference in Washington, DC called "SEC Speaks," speakers from the U.S. Securities and Exchange Commission reiterated the need for robust disclosures to promote "fair and orderly markets."

Of course more disclosure does not always translate into better disclosure but certainly there are numerous best practices as to how numbers should be reflected to empower investors and plan participants with what they need to know. As I have said many times, numbers are helpful but certainly not the totality of the risk factors that should be considered with any vendor or asset manager relationship. The process of vetting economic, fiduciary and operational risks (among others) is a complex but hugely necessary expenditure of time and money.

Europe Readies For High Frequency Trading Compliance

Susan Mangiero — Fri, 24 Feb 2012 23:12:05 -0500

In addition to sovereign debt restructuring, European financial market executives have a new mandate - high frequency trading governance. On February 24, 2012, the European Securities and Markets Association ("ESMA") published the final version of "Guidelines on systems and controls in an automated trading environment for trading platforms, investment firms and competent authorities" in all official languages of the European Union ("EU"). As a result, regulatory supervisors must "declare whether they intend to comply with the guidelines or otherwise explain the reasons for non-compliance."

What caught this blogger's attention is the document's emphasis on governance as being "central to compliance with regulatory obligations" and having to address technical, business and operational risks, among other things. The document continues that policies and procedures must be in place to monitor a firm's trading systems and algorithms for adherence with the firm's internal control requirements. Additionally, it is critical for a firm to be able to detect when failures occur.

Whether these directives have an impact on high frequency trading remains to be seen. Bruce Love does a nice job of explaining the likely impact of ESMA's guidance. See "ESMA's HFT rules widen net, cash shadow over dark pools" (The Trade, January 24, 2012).

ERISA and Securities Litigation Snapshot -- Things You Can Do Now to Minimize CFO and Board Liability

Susan Mangiero — Tue, 21 Feb 2012 00:19:47 -0500

In the last few years, pension funding levels and 401(k) account balances have fallen dramatically. New disclosure rules, volatile market conditions, investment complexity and mandatory cash contributions are only a few of the many challenges that are unlikely to go away. Not surprisingly, ERISA litigation continues to grow, along with lawsuits related to employee benefit plan governance. Personal liability claims against C-level executives and board members have become the normal.

Join FTI Consulting and the Securities Docket for a timely and informative webinar about the link between employee benefit plan management and shareholder value.

During this 60 minute live event, attendees will learn:

Why ERISA litigation claims against top executives and board members continue to grow
How securities litigation and ERISA filings are related and what it means for corporate directors and officers
What ERISA liability insurance underwriters want clients to demonstrate in terms of best practices
What steps the Board and top executives can take to minimize their liability
What investment fiduciary bad practices to avoid
When to get the CFO and board members involved

The distinguished panel includes (a) Attorney Jim Baker, ERISA litigator of the year for 2012 and a partner with Baker & McKenzie (b) Ms. Rhonda Prussack, EVP and Fiduciary Liability Product Manager for Chartis (c) Mr. Gerry Czarnecki, governance guru and State Farm Insurance board member and (d) Dr. Susan Mangiero, Managing Director with FTI Consulting’s Forensic and Litigation Consulting Practice in New York.

To register for this March 7, 2012 webcast, click here.

Pension Risk Management and Governance: Challenges and Opportunities in a New Era

Susan Mangiero — Wed, 04 Jan 2012 00:58:01 -0500

Please join me and fellow panelists on January 24, 2012 fro. 4 to 6 pm for a topical discussion about pension risk management and governance. Given that the last few years have posed unprecedented challenges for plan sponsors, both corporate and public, as well as their asset managers and consultants, life in employee benefit land will never be the same again. Market volatility, low interest rates, increased scrutiny about carrying out fiduciary duties, calls for better disclosure and greater complexity keep pension decision-makers busy.

Hear what legal and financial professionals have to say about what keeps plan sponsors and their advisors and asset managers up at night and how they can implement best practices for pension risk management within a fiduciary framework.

The roster of speakers who will address both defined benefit and defined contribution plan best practices and concerns include:

Mr. William Carey, President, F-Squared Retirement Solutions
Attorney Gordon Eng, General Counsel and Chief Compliance Officer, SKY Harbor Capital Management, LLC
Dr. Susan Mangiero, CFA, FRM, Risk and Valuation Consultant and Expert Witness
Attorney Martin J. Rosenburgh, CFA

Information about the speakers is shown below:

William Carey, President
F-Squared Retirement Solutions
Mr. Carey is President of F-Squared Retirement Solutions, a subsidiary of F-Squared Investments. F-Squared is a privately held SEC registered investment advisory firm providing investment advisory and portfolio management services for financial professionals, wealth managers, and institutional investors. Mr. Carey has over 25 years of experience in the financial services and retirement industry. Previously, Mr. Carey led the retirement business for Bank of America and distribution and client management for Bank of America/Merrill Lynch retirement. Mr. Carey spent 14 years with Fidelity where his responsibilities included serving as President of Fidelity Institutional Retirement Services Company and Fidelity Registered Investment Advisor Group. Prior to Fidelity he worked for Aetna Life in Casualty in their employee benefits division. Mr. Carey received a Bachelor of Arts degree in economics from Bates College in 1982. He has served on a number of industry and not-for-profit boards and is currently on the board of trustees for Bates College.

Gordon Eng, General Counsel and Chief Compliance Officer
SKY Harbor Capital Management, LLC
Gordon Eng is General Counsel and Chief Compliance Officer of SKY Harbor Capital Management, LLC, a registered investment advisor established in August 2011 and headquartered in Greenwich, CT, with a focus on managing core high yield and short duration high yield bond portfolios for institutional and high net worth individuals in and outside the United States. Prior to joining SKY Harbor Capital Management, Mr. Eng was a litigation associate at the law firm of Debevoise & Plimpton LLP in New York where his practice focused on white collar, internal investigations, regulatory defense, and commercial litigation of complex financial instruments. Mr. Eng was admitted to the bar in New York in 2005 and is admitted to appear before the US District Courts for the SDNY and EDNY, and the 2d Cir. Court of Appeals. His registration as an out-of-state authorized house counsel in Connecticut is pending. His published works include: "Regulatory Investigations and the Credit Crisis: The Search for Villains," co-authored in American Criminal Law Review's 2009 Annual Survey of White Collar Crime (2009), "Forging Ahead on E-Discovery," co-authored in the New York Law Journal (2006) and "Old Whine in a New Battle: Pragmatic Approaches to Balancing the Twenty-First Amendment, the Dormant Commerce Clause, and the Direct Shipping of Wine," Fordham Urban Law Journal (2003). Mr. Eng serves on the Board of Directors of the New York County Lawyers' Association (NYCLA). He is also a co-vice chair of the NYCLA Ethics Committee and a founding member of the Advisory Board of the NYCLA Ethics Institute. He is a contributing editor to the publication New York Rules of Professional Conduct (2010), which is edited by the NYCLA Ethics Institute. Mr. Eng is a member of American Bar Association, the House of Delegates of the New York State Bar Association, and the Litigation Committee of the Asian American Bar Association of New York. Mr. Eng is a recipient of the 2010 Legal Aid Society's Pro Bono Publico Award in recognition of his representation of Legal Aid Society clients in Manhattan criminal court. Mr. Eng began his career as an international bank lending officer at Manufacturers Hanover Trust Company, and was also a foreign currency trader at Bankers Trust Co., Bank of Tokyo Ltd., Lehman Brothers and JPMorgan Chase and a legal intern at the United States Attorney's Office, Southern District New York, Criminal Division from 2003-2004. Mr. Eng received his J.D., magna cum laude, from Fordham University School of Law, Order of Coif in 2005 where he was a published member of the Fordham Urban Law Journal. He received his M.B.A. from New York University, Stern School of Business with honors and his B.S. in Economics from the Wharton School of the University of Pennsylvania.

Susan Mangiero, PhD, CFA, FRM, Managing Member
Fiduciary Leadership, LLC
Dr. Susan Mangiero offers independent risk management and valuation consulting, litigation support and training. She has provided testimony before the ERISA Advisory Council, the OECD and the International Organization of Pension Supervisors. Dr. Mangiero has served as an expert witness as well as offering behind-the-scenes forensic analysis, calculation of damages and rebuttal report commentary for a variety of investment governance, performance, risk and valuation matters. She has over twenty years of experience in capital markets, global treasury, asset-liability management, portfolio management, economic and investment analysis, derivatives, financial risk control and valuation, including work on trading desks for several global banks, in the areas of fixed income, foreign exchange, interest rate and currency swaps, futures and options. Dr. Mangiero has provided advice about risk management, modeling, hedge effectiveness and valuation best practices for a wide variety of consulting clients and employers that includes General Electric, PriceWaterhouseCoopers, Mesirow Financial, Bankers Trust, Bank of America, Chilean pension supervisory, World Bank, Pension Benefit Guaranty Corporation, RiskMetrics, U.S. Department of Labor, Northern Trust Company and the U.S. Securities and Exchange Commission. Dr. Mangiero is the author of Risk Management for Pensions, Endowments and Foundations (John Wiley & Sons, 2005), a primer on risk and valuation issues, with an emphasis on fiduciary responsibility and best practices. Her articles have appeared in Expert Alert (American Bar Association, Section of Litigation), Hedge Fund Review, Investment Lawyer, Valuation Strategies, RISK Magazine, Financial Services Review, Journal of Indexes, Family Foundation Advisor, Hedgeco.net,Expert Evidence Report, Bankers Magazine and the Journal of Compensation and Benefits. Dr. Mangiero has written chapters for several books, including the Litigation Services Handbook and The Handbook of Interest Rate Risk Management. In addition to her contributions to www.pensionriskmatters.com, a popular award-winning and syndicated blog, she launched a second blog that addresses compliance and investment best practices for all types of institutional investors, www.goodriskgovernancepays.com, in early 2011. She is a frequently invited speaker and has keynoted or led workshops for organizations such as the Stable Value Investment Association, Harvard Law School, Florida Public Pension Trustees Association, New York State Department of Insurance, Association of Public Pension Auditors, AICPA - Employee Benefits Section, National Association of Corporate Directors and Financial Executives International.

Martin J. Rosenburgh, CFA, Esquire
Martin Rosenburgh is an attorney with an investment management focus and also a financial analyst. Mr. Rosenburgh currently serves as a securities compliance consultant to investment managers and service providers within the investment management industry. In addition, he provides litigation consulting services to several law firms, representing investment manager clients in SEC examinations and audits and providing expertise and support on large-scale securities law matters (including Madoff feeder-fund, Refco, and WaMu litigations), and also provides independent business valuation research and advisory services. Finally, he serves as consultant to Hudson Pilot, an asset liability management solutions boutique, where he has assisted in development and implementation of portfolio strategies for defined benefit plan sponsors and endowments, performing macroeconomic research and providing advice on retirement plan funding and design issues. Recent other clients include Morvillo Abramowitz, Marcum LLP, RegEd, Zaitzeff Law P.C., BONYM, South Street Securities, A.S.A.P. Advisory Services and First State Trust Company. In addition, he has served as an associate at Proskauer Rose LLP, Pryor Cashman LLP and Grotta Glassman and Hoffman, PA, where he has advised employee benefit plans and investment trusts with respect to the full range of ERISA, fiduciary and tax qualification issues, including the design and implementation of employee benefit plans and arrangements. He served internships early in his legal career with the Office of the United States Attorney, Eastern District, Brooklyn, NY and the United States Department of Labor, Office of the Solicitor, New York, NY. He also has experience as a senior trader with Assent LLC (division of SunGard). Mr. Rosenburgh received a JD from Brooklyn Law School, Brooklyn, NY, and a BA from Cornell University, Ithaca, NY, and holds the Chartered Financial Analyst designation.

Investment Risk Governance, Litigation and Compliance

Susan Mangiero — Sat, 03 Dec 2011 23:48:15 -0500

There are so many interesting insights and analyses we plan to share. It is hard to know where to begin.

We will resume active blogging on January 1, 2012.

In the meantime, have a wonderful holiday season.

Prioritizing Risk Management

Susan Mangiero — Thu, 14 Jul 2011 23:39:17 -0500

I recently had the pleasure of contributing an article about the importance of risk management and service provider due diligence to The Glass Hammer website. For those who are not familiar with the group, check out www.TheGlassHammer.com to learn about this award-winning blog and online community created for women executives in finance, law, technology and big business. See below or click on "Thought Leaders: Prioritizing Risk Management" to read the full text of this commentary about the benefits of risk mitigation well done and the costly consequences of inattention or sloppy practices.

Full Text:

Thought Leaders: Prioritizing Risk Management, July 14, 2011, 1:00 pm

Contributed by Susan Mangiero, PhD, Investment Risk Governance Consultant and Author

For those financial institutions which have yet to grasp the importance of identifying, measuring, managing, and monitoring risks on a comprehensive basis, time may not be on their side. Regulators and litigators alike are forcing change.

There are countless individuals who want better information from their service providers about risk and are prepared to vote with their feet if they don’t get good answers. After all, these institutional investors themselves are confronted with a bevy of new mandates that require transparency. The good news is that change opens the door to business opportunities. Enlightened organizations that have good processes in place and have nothing to hide can differentiate themselves from competitors. Providing clients with education and data tools offers yet another way for asset managers, consultants, banks, and advisors to forge stronger relationships with their pension, endowment, foundation and family office clients. On the flip side, those who are reluctant to explain how they manage their financial, operational and legal risks may lose clients or worse yet, could end up as defendants in a lawsuit.

Pay to play conflicts, questions about hidden fees, state and federal legislation and new accounting rules are a few of the forces at work to ensure that trillions of institutional dollars are in good hands. Effective investment stewardship is no longer a luxury. Recent surveys confirm that buy side decision-makers continue to emphasize governance and risk management for their organizations as well as providers of products and services. Institutional investors can ill afford to lose money after a tumultuous few years. Investment committee members who give short shrift to fiduciary duties could end up being investigated by regulators or sued. According to federal court data, the number of ERISA lawsuits is going up. Factor in investment arbitrations, enforcement actions and “piggyback” securities litigation allegations and it is clear that unhappy investors are not going to accept the status quo.

1. Fiduciary Focus

Besides efforts underway by the U.S. Securities and Exchange Commission (SEC), the U.S. Department of Labor (DOL) has proposed an expanded definition of who should serve as a fiduciary to ERISA employee benefit plans. If adopted, countless more professionals will be tasked with demonstrating procedural prudence when it comes to the investment of over $30 trillion in money from corporate retirement plan sponsors. States are likewise seeking change in the form of trust law reforms that tighten accountability for the investment of monies held by endowments, foundations and charities. The questions now being addressed by judges and arbitration panels relate to “excessive” risk-taking, insufficient diversification, absence of independent assessments of hard-to-value instruments and oversight failures that have led to large losses that might have been highly preventable.

One asset management firm recently settled with the SEC for $242 million over a mistake with one of its risk management models. Another firm just settled with the SEC for $200 million due to problems in the way subprime securities were marked. A few years ago, a Northeast pension plan was sanctioned by the DOL for not having thoroughly vetted valuation numbers provided by one of its hedge fund managers.

When I testified before the ERISA Advisory Council in 2008, I emphasized that having good valuation policies and procedures is essential because it impacts so many decisions having to do with asset allocation, hedging and fees paid.

2. Data Mining for Gold

Data analysis is a cornerstone of effective risk management but only if inputs are considered good. Garbage in, garbage out can be disastrous and costly. The use of unreliable, incomplete or inaccurate data points can result in bad decisions being made about measuring and controlling risks. Since risk

management is integral to investment management, other decisions such as portfolio rebalancing may be flawed as a result. Moreover, data is not created equal. Consider a few examples. Yields for a constant maturity security are not the same as yields on particular financial instruments with a fixed maturity date. Betas can be levered or unlevered. Mutual fund returns may not include all relevant fees, let alone the timing as to when the fees are charged. Hedge funds that utilize side pockets will report performance numbers that are skewed as a result. For an institutional investor that is trying to decide how to best manage risk or make sure that its service provider is properly controlling risk, one has to first measure the numerous risks that can spell trouble if left unchecked.

I’ve been fortunate to have worked on various projects where I had to thoroughly understand data quality exigencies before I could conduct statistical analyses that in turn were used for risk management or compliance purposes. While pursuing my PhD in finance, I took extra math and statistics courses to strengthen my data analysis skills. My doctoral research on trading patterns and market liquidity required extensive vetting of transaction data that was provided by the New York Stock Exchange. When I worked in the treasury department of a Fortune 500 company, I had to review and assimilate large amounts of data about a $200+ million derivative instrument portfolio in order to make recommendations about hedging strategies and risk monitoring technology functions. When I now serve as an expert witness on financial litigation matters, I spend copious amounts of time with relevant data to first understand what it means and then evaluate what could have been done differently to avoid losses. Data analysis is an important component of estimating economic damages that a judge or arbitration panel will review for settlement or award purposes.

Making decisions based on numbers alone is not the way the business world works. There are qualitative and quantitative risks that cannot be ignored but, of course, decisions and data do need to be aligned.

3. Everyone is a Risk Manager

There is no sector of the investment management industry that is immune from risk management. Due diligence meetings increasingly focus on what asset managers, banks and other service providers are doing to manage their risks. Pension committee members are being asked to account for how they select managers and investments with more details about prudent process. Donors are reluctant to give money to non-profits without assurances that risks are under control. Auditors are tasked to ensure that models for hard-to-value instruments are regularly monitored for appropriateness. Board members and compliance officers are in the spotlight for their oversight of risk-taking and the extent to which investors are kept abreast about controls.

Risk management is an important means to an end. It is in everyone’s best interest to identify, measure, manage and monitor risks. Otherwise, it comes down to being lucky or not. Try explaining whim to investors, shareholders, taxpayers, litigators and/or regulators.

In addition to a plethora of articles about risk management and valuation, Susan Mangiero, PhD, CFA, FRM is the author of Risk Management for Pensions, Endowments and Foundations. She is busy at work on a new book about investment risk governance. Mangiero is the architect behind an award-winning, syndicated blog found at www.pensionriskmatters.com. A second blog found at www.goodriskgovernancepays.com focuses more broadly on investment risk governance for all types of institutional investors and their advisors and attorneys.