Risk Rap

Rapping About a World at Risk

Leaking Visions of a New World Order

Every once a while an event happens that shifts the prevailing scheme of things. Julian Assange’s dump and release of US State Department cables (CableGate) for global distribution on WikiLeaks is such an event. It radically alters existing convention and the public’s general perception of normalcy, acceptability and protocol.  It brings into question the motives and interests of nations and their leaders. It squarely plops an 800 pound gorilla on the sofa in everyone’s living room and provokes questions that naggingly insist answers.   Asking leaders about duplicity, conflicts of interest, distortions, fabrications, fibs and outright lies all done in the national interest.  It is how a new Weltanschauung is cast and forged to conform to the needs a new world order.  The sun has set on the American Century.  Blessedly, America’s days as a self righteous post Cold War marauding superpower are coming to a close.  The WikiLeaks disclosures gives us some insights into the thinking and banter world leaders engage as they move the Chess pieces across the board on the great global game  of new world order.

There are moral considerations and ethical arguments to be made on each side of Mr. Assange’s incendiary action.  CableGate raises complex multidimensional issues of national security, informed citizenry, the protection of information, its public disclosure and citizens right to know.  The natural tension between  the simultaneous need for confidentiality and transparency is a reality of our complex and interconnected world.  The management of these issues have escalated to become a preeminent dilemma of our time.  This raises significant  challenges to democratic societies and the governance structures of both public and private institutions.  It threatens institutional sustainability and undermines institutional capability to function in highly interdependent stakeholder ecosystems.  The risk of seeking pathways to safely navigate the virtual minefields of a digitized global world is great and continues to grow.

The most impassioned issue raised by CableGate is the ethical violation of stolen property.  The cables were not Mr. Assange’s property and what gives him the right to publish and violate diplomats right to confidentiality and privacy? His actions could endanger diplomatic relationships, compromise government initiatives or derail delicate negotiations.  Do governments have a right to privacy?  If so, what information needs to be classified as secret and confidential?  If all documents are secret then the designation is meaningless and government nothing more then a ruthless leviathan lording over a clueless citizenry.

Another critical question CableGate raises is who is served by the publication of these cables? Certainly American citizens in whose interest the State Department purportedly acts benefits from the added transparency.  US citizens must admit there is a certain level of comfort in being able to track the satchel of an Afghanistan Vice President stuffed $52 million of taxpayers money through the U.A.E. Customs.

Detractors of CableGate assert that the leaks are a danger to America and its citizens.  If so why is the public aggrieved and who exactly is the “aggrieved public”?  Soldiers and servicemen fighting in Afghanistan?  Does State Department Cables provide tactical and strategic information on troop deployments?  Highly doubtful.  More likely it is the special interests enriching themselves at the public troughs by cutting deals to shamelessly engorge themselves as insidious war profiteers.  Better to ask why our country has placed our young servicemen and woman at risk in wars that makes little sense and accomplishes nothing.

Another set of critical questions CableGate raises are “Do citizens have a right to truth?  Is access to information meaningful?  Does the information help citizens of democratic societies understand the actions and motivations of their government?  Why do diplomats pursue certain course of action and who is profiting from the course of action pursued?  These are critical tenants citizens require to make informed decisions in a democratic society and CableGate certainly supports the notion of information empowerment for citizens.

Arguing the contrary one must ask “is it better to be mislead and be lied too in the name of propriety and protocol then to be victimized by the truth?  I’ll take conviction in a court of truth and pray for a life sentence every time.

If you believe that the public can’t handle the truth or needs protection from it; imagine yourself living near a nuclear power plant and it was leaking radiation into your drinking water.  Would you like to know about it?  What if disclosure led to wide spread panic?  I believe that truth and transparency always serves to discover and determine the best course of action to pursue.

CableGate has also shed damaging light on the power exercised by private corporations and the commercial control and open access and free availability of information.  Amazon’s cloud computing service had no silver lining for WikiLeaks.  After the WikiLeak dump it shut down access to the cables due to the unacceptable risk posed by denial of service attacks mounted by computer hackers.   This was followed by PayPal’s closure of WikiLeaks donation solicitation account.  Was PayPal’s motive purely patriotic?  Where they just pissed at WikiLeaks or were they at risk of  aiding and abetting a subversive organization that risked prosecution under certain provisions of  THE USA PATRIOT ACT?

Academic freedom also seems to have taken a blow due to CableGate.  This weekend, Columbia University warned its students not to download or distribute WikiLeak cables because it may affect future employment opportunities with the State Department. Government employees were also warned not to read or access the cables because they had no security clearance to do so.  If they were caught accessing the leaked cables it could cost them their jobs.  Even though the cables are published in great detail everyday by newspapers throughout the world, government employees must be careful not to notice for risk of losing their employment.  This is truly a Kafkaesque dilemma for some, a divine comedy for others and a growing political drama for everyone.

I’m still not sure that Cablegate is what it purports to be.  As the old saying goes and the cables affirm nothing is ever as it seems.  I find it  most improbable that a Private First Class sitting at a PC in Baghdad could download the Iraq War Logs and throw a great superpower into a first class crisis of the new world order.  I liken the leaks  to the past practice  of “special unnamed high placed sources” leaking inside information to the liberal mainstream media outlets.  Its done to float trial balloons about new government directions.  They do it to test the waters of public sentiment to new ideas, or change in policy course or  potentially damaging information to see how the public reacts.  Not one to be of a conspiratorial mindset, I perceive CableGate in this light.  As expected the public reaction thus far  has elevated our collective sense of outrage to a heightened level of ambivalence.

In many respects Iraq War Logs supports the construction of a new narrative about an exit strategy from Iraq and Afghanistan.  The revelations of wastefulness, corruption and back room deal making with a full caste of sordid characters reinforces  the public perception about the uselessness of these wasteful and expensive misadventures.  The cables may prove to be the documentary evidence  of  America’s Waterloo and CableGate  may be seen by future generations as the  historical high watermark of an expired global empire.

As the Iraq and Afghanistan War Logs helped to prepare the public psyche for an exit strategy in Afghanistan and Iraq; CableGate helps construct a narrative surrounding the need to “cut off the head of the snake in Iran”.  These cables implicate Arab States in a desire to undermine the apostate Persians and abrogates Israeli culpability as the driving force behind an attack on Iran.

Iranian President Mahmoud Ahmadinejad called the cables psychological warfare.  I don’t doubt for a second that atomic weapons in the hands of Iran is a dangerous development that needs to be mitigated.  That does not mean that we should employ bombers to destroy Iranian nuclear processing facilities.  This would only create an environmental disaster and political crisis  that further destabilizes the region.  It would secure the enmity of new generations of Muslims and no doubt stoke the escalation of the Crusade against Islam.

In the Far East,China’s growth as a world super power and ascending rival to US dominance makes for compelling reading.  Here its no surprise that cables assess a strengthening China, its growing nationalism and military readiness.  Reading these cables against the backdrop of rising tensions on the Korean peninsula, China’s complicity in helping North Korea ship nuclear materials to Iran and the changing sentiment in the US concerning the largest note holder of government bonds may prove to  carry grave consequences for harmonious US/China relations.   The cable revealing China’s ambivalence toward its North Korean surrogate state is laid bare as long as it can secure preferred trade agreements with a unified Korea.

The revelations offered by Pakistan’s leaders about support for the Taliban and a growing concern about the safety of their nuclear arsenals raised the possibility of a US military move to quarantine or neutralize Pakistani weapon systems.  Though so far India seems to come off unscathed by the cables it must be heartening for India’s leaders to know that its budding friendship with the US may encourage a move to disarm the nuclear capability of its northern antagonist and the worlds sole Islamic atomic state.

These WikiLeaks offer up a brand new narrative for an emerging new world order.  The damaging realization of the spillage of confidential proprietary discussions and dialogs between world governments and the mishandling of those documents diminishes the stature of US federalism.  The undermining of federalism and its suitability as a governance structure for the new millennium foreshadows the growing antagonism of global corporate entities like Google and the nationalistic government of the People’s Republic of China augers an era of  conflict between statism and corporatism.

CableGate is a deliberate attempt to have institutions open up with greater transparency and construct a democratic narrative that force governments to change.  Mr. Assange’s  avowed goal is to, “allow governments and institutions to become more transparent or force them to become more opaque”  Depending on the what side of the fence your sitting on, openness and transparency benefits the public interest.  The struggle for democracy requires the open access and the free flow of information.

In the digital age denial of free, open and equal access to information is tantamount to fascism.  Withheld, it will encourage people to rise up demanding the means to pursue conscious enlightenment.  This may spur political activism that demands institutional accountability,  and the practice of democratic governance based on constitutional principles.  Failing that once free citizens will be forced to accept the meager lies and obfuscations of leaders and power elites whose self interest is the sole interest of government.

So as Secretary of State Hillary Clinton tries to plug the leaks in a failing dike system, we cannot content ourselves to live with our heads buried in the sand,  filling our minds with reality TV reruns of Jack Ass Three and Bristol Palin bustin a move on Dance Fever.  I’ve heard it said that the best way to influence the future is to invent it.  Mr. Assange has given us a world of insights and a basic tool set to start constructing a foundation for a new world order.

You Tube Music Video: REM, End of the World As We Know It

Risk: diplomacy, international relations, governance

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December 6, 2010 Posted by | Cablegate, corporate governance, corruption, culture, democracy, ethics, government, institutional, Iraq War Logs, legal, nuclear, peace, politics, psychology, reputational risk, terrorism, values, war, WikiLeaks | , , , , , , , , , , , , , , , , , , , | Leave a comment

Liberty and Justice for All

Today is Gay Pride Day in New York City.  The march commemorates the Stonewall Uprising by Gay men in a Greenwich Village bar over 40 years ago.  Stonewall was a watershed event for everyone.  It was a poignant reminder to all people that a specific population of our citizens were the victims of harassment and repression because of their sexual identity.  Stonewall was a bold proclamation that the LGBT community would no longer suffer in silence and shame.  Refusing to be victimized,  LGBT people would courageously come out of the closet at great personal cost to claim their place at the table of the worlds great democratic republic.  It is the very same spirit and motivation that led to the creation of the United States and its promise of liberty and justice for all.

Sodomy Laws prohibiting homosexuality and its practice has been on the books of state and municipal law since the founding of our republic.   Jefferson wrote the first sodomy law in Virginia in 1778,  proposing castration for those found guilty of the act. Pretty amazing that during the height of the Revolution, Virginia took time to write laws prohibiting homosexuality.  I also find it a bit ironic that as revolutionaries were striking a blow to end the rule of a foreign tyrannical monarchy they would focus their attention to pass a tyrannical law aimed at repressing the rights for a portion of its citizens.

Sodomy laws find their inspiration and justification in a biblical certainty proclaimed by parties that remain painfully at odds with the promises and problems of secular democratic government.  Proponents of  laws prohibiting civil rights to LGBT offer a world view informed by Old Testament precepts and proscriptions authored two thousand years ago.  Their moral compass seems to be ruled more by a dogmatic creed enforced by a vengeful deity.  In their zeal to live a pious life they seem to miss the greater message that all God’s children enjoy full and equal rights in God’s Kingdom and that we demonstrate our love of God by extending that love to others.

Those that oppose equal and full rights of citizenship to all people are the avowed enemies of democracy.  Democratic republics cannot survive if it withholds any right or civil liberty to a group of its citizens based on a legislative distinction of acceptability.  Indeed, today’s proponents of laws like Proposition 8, Defense of Marriage Laws, the prohibition of gays openly serving in the military or the denial of the right for a teenage girl to go to the prom with her girlfriend share a mindset more in common with the Taliban then our Founding Fathers.  We recoil in horror as we witness the divinely inspired handiwork of the Taliban and rise to meet it with a national resolve to assert and protect the sacred liberties offered by secular democratic governments.  Given a choice and a true understanding of what is at stake, I pray that my countrymen will join me in support of equal rights and civil liberties for all citizens.

Frederick Douglas’s famous quote that “power concedes nothing without demand”, is as relevant today as it was when the great abolitionist spoke these words.  Douglas states,  “If there is no struggle there is no progress. Those who profess to favor freedom and yet depreciate agitation…want crops without plowing up the ground, they want rain without thunder and lightening. They want the ocean without the awful roar of its many waters…. Power concedes nothing without a demand. It never did and it never will.”

We salute the Gay Pride Marchers as they step off  this morning  to remind us that liberty and justice for all remain beyond compromise and an absolute necessity for America to remain true this promise for all its citizens.

You Tube Music Video: Bob Marley and the Wailers, Get Up Stand Up

Risk: democracy, civil rights, 

June 27, 2010 Posted by | culture, democracy, government, legal, LGBT, politics, religion, social justice | , , , , , , , , , , , , , , , | Leave a comment

Hedge Funds Navigating Industry Sea Change

This years Schulte Roth Zabel’s (SRZ) 19th Annual Private Investment Funds Seminar stuck a very different pose from last years event. One year on from the global meltdown of financial markets, languishing institutional certainty and the pervading crisis of industry confidence has been replaced with a cautious optimism. The bold swagger of the industry however is gone, in its place a more certain sense of direction and expectation is emerging. Though managers continue to labor under unachievable high water marks due to the 2008 market devastation, 2009 marked a year of exceptional performance. Investment portfolios rebounded in line with the upturn in the equity and bond markets. Liquidity improved and net inflows into the industry has turned positive during the last quarter as large institutional investors and sovereign wealth funds returned to the sector with generous allocations. These are taken as clear signs that the industry has stabilized and the path to recovery and the healing of economic and psychological wounds are underway. Yes the industry will survive and ultimately thrive again but it will do so under vastly different conditions. The new business landscape will require an industry with a guarded culture of opaqueness to provide much greater transparency while operating under a regimen of greater regulatory scrutiny.

The 1,900 registered attendees heard a message about an industry at a cross road still coming to terms with the market cataclysm brought on by unfettered, unregulated markets and excessive risk taking. SRZ offered an honest assessment in examining the industries role in the market turmoil. Speakers alerted attendees to an industry at a tipping point. To survive the industry must adapt to a converging world that believes that uniform market rules and regulations are the surest safeguards against catastrophic systemic risk events. A global political consensus is emerging that expresses support for industry regulation as an effective tool to mitigate the pervasiveness of fraud and market manipulation that undermines investor confidence and ultimately the functioning of a fair and efficient open free market.

Paul Roth, Founding Partner of SRZ, noted in the events opening remarks that the market is beginning to recover as evidenced by industry AUM once again exceeding the $2 trillion mark; but he warned that any exuberance needs to be tempered with the understanding that the new normal would not resemble the pre-crash world. The days of cowboy capitalism and radical laissez-faire investing are clearly over. Indeed Mr. Roth wryly observed “the industry must develop a maturity about the need for change. He concluded “that the industry must respond by playing a constructive role in forming that change.”

The conference subject matter, speakers and materials were all top shelf. Break out presentations on risk management, regulatory compliance, distressed debt deal structuring, tax strategies and compensation issues all reinforced the overriding theme of an industry in flux. The presenters passionately advocated the need to intentionally engage the issues to confront accelerated changes in market conditions. By doing so, fund complexes will be in a position to better manage the profound impact these changes will have on their business and operating culture. Subject issues like insider trading, tax efficient structuring, hedge fund registration, preparing for SEC examinations and the thrust of DOJ litigation initiatives and how to respond to subpoenas were some of the topics explored.

To highlight the emerging regulatory environment confronting the industry, a presenter pointed to the Southerization of the SEC. This is an allusion to the hiring of former criminal prosecutors from the Department of Justice, Southern District of New York to go after wayward fund managers. The SEC is ramping up its organizational capability to effectively prosecute any violations of the new regulatory codes. The growing specter of criminal prosecutions and the growing web of indictments concerning the high profile case of Mr. Raj Rajaratnam of the Galleon Group was presented as evidence of an emerging aggressive enforcement posture being pursued by regulators. Managers beware!

Presenters made some excellent points about how institutional investors are demanding greater levels of TLC from their hedge fund managers. This TLC stands for transparency, liquidity and control. Creating an operational infrastructure and business culture that can accommodate these demands by institutional investors will strengthen the fund complex and help it to attract capital during the difficult market cycle.

The evening concluded with an interesting and honest conversation between Paul Roth and Thomas Steyer, the Senior Managing Partner of Farallon Capital Management. The conversation included increased regulatory oversight, compensation issues, industry direction and matching investor liquidity with fund strategy, capacity, structure and scale. Mr. Steyer manages a multi-strategy fund complex with $20 billion AUM, his insights are borne from a rich industry experience. He made the startling admission that Farallon has been a registered hedge fund for many years and he believes that the regulatory oversight and preparation for examiners reviews helped his fund management company to develop operational discipline informed by sound practices.

Mr. Steyer also spoke about scale and that additional regulatory oversight will add expense to the cost of doing business. Mr. Steyer believes that it will become increasingly difficult for smaller hedge funds to operate and compete under these market conditions.

Another interesting topic Mr. Steyer addressed were issues surrounding investor redemption and fund liquidity. During last years SRZ conference investor liquidity was the hot topic. Fund preservation during a period of market illiquidity and a fair and orderly liquidation of an investment partnership were major themes that ran through last years presentations. Mr. Steyer struck a more conciliatory tone of investor accommodation. He confessed his dislike for the use of “gates” as a way to control the exit of capital from a fund. In its place he offered a new fund structure he referred to as a “strip” to allocate portfolio positions to redeeming partners in proportion to the overall funds liquid and illiquid positions. He stated he believed that strategy to be more investor friendly.

Schulte Roth & Zabel has once again demonstrated its market leadership and foresight to an industry clearly in flux, confronting multiple challenges. These challenges will force fund managers to transform their operating culture in response to the sweeping demands of global market pressures, political impetus for regulatory reform and the heightened expectations of increasingly sophisticated investors. The industry could not have a more capable hand at the helm to help it navigate through the jagged rocks and shifting shoals endemic to the alternative investment management marketplace.

You Tube Music Video: Beach Boys, Sail On Sailor

Risk: industry, market, regulatory, political

January 16, 2010 Posted by | commerce, compliance, corruption, hedge funds, investments, legal, off shore, private equity, regulatory, reputational risk, risk management, SEC, sovereign wealth funds | , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , | 1 Comment

Audit Risk Survey for Fund Managers: Final Results

tax-return1Sum2 is please to report the final results of the IRS Audit Risk Survey for Fund Managers. Sum2 has commissioned the survey to determine financial services industry awareness and readiness for IRS audit risk factors. The survey sought to determine industry awareness and readiness to address IRS Industry Focus Issue (IFI) risk exposures for hedge funds, private equity firms, RIAs, CTAs and corporations using offshore structures.

Survey Background

Due to the pressing revenue requirements of the United States Treasury and the need to raise funds by recognizing new sources of taxable revenue; hedge funds, private equity firms, CTA’s and other corporations that utilize elaborate corporate structures, engage in sophisticated transactions and recognize uncommon forms of revenue, losses and tax credits will increasingly fall under the considered focus of the IRS.

Since 2007 the IRS began to transition its organizational posture from a benign customer service resource to a more activist posture that is intent on assuring compliance and enforcement of US tax laws. Specifically the IRS has invested in its Large and Mid-Size Business Division (LMSB) to enhance its expertise and resources to more effectively address the tax audit challenges that the complexity and sophistication of investment management complexes present. The IRS has developed its industry issue competencies within its LMSB Division. It has developed a focused organizational structure that assigns issue ownership to specific executives and issue management teams. This vertical expertise is further enhanced with issue specialists to deepen the agencies competency capital and industry issue coordinators that lends administrative and agency management efficiency by ranking and coordinating responses to specific industry issues. IRS is building up its portfolio of skills and industry expertise to address the sophisticated agility of hedge fund industry tax professionals.

To better focus the resources of the agency the IRS has developed a Three Tiered Industry Focus Issues (IFI). Tier I issues are deemed most worthy of indepth examinations and any fund management company with exposure in these areas need to exercise more diligence in its preparation and response. Tier I issues are ranked by the IRS as being of high strategic importance when opening an audit examination. This is followed by Tier II and Tier III focus issues that include examination issues ranked according to strategic tax compliance risk and significance to the market vertical. Clearly the IRS is investing significant organizational and human capital to address complex tax issues of the industry. The IRS is making a significant institutional investment to discover potentially lucrative tax revenue streams that will help to address the massive budget deficits of the federal government.

Survey Results

The survey was open to fund management executives, corporate treasury, tax managers and industry service providers. CPAs, tax attorneys, compliance professions, administrators, custodians and prime brokers were also invited to participate in the study. The survey was viewed by 478 people. The survey was completed by 43% of participants who began the survey.

Geographical breakdown of the survey participants were as follows:

  • North America 73%
  • Europe 21%
  • Asia 6%

The survey asked nine questions. The questions asked participants about their awareness of IFI that pertain to their fund or fund management practice and potential mitigation actions that they are considering to address audit risk.

The survey posed the following questions:

  • Are you aware of the Industry Focus Issues (IFI) the IRS has developed to determine a fund managers audit risk profile?
  • Are you aware of the organizational changes the IRS has made and how it may effect your firms response during an audit?
  • Are you aware of the Three IFI Tiers the IRS has developed to assess a funds audit risk profile?
  • Are you aware of how the Three IFI Tiers may affect your audit risk exposures?
  • Have you conducted any special planning sessions with internal staff to prepare for IFI audit risk exposures?
  • Has your outside auditor or tax attorney notified you of the potential impact of IFI risk?
  • Have you held any special planning meetings with your outside auditors or tax attorneys to mitigate IFI risk?
  • Have you had meetings with your prime brokers, custodians and administrators to address the information requirements of IFI risk?
  • Have you or do you plan to communicate the potential impact of IFI risk exposures to fund partners and investors?

Survey highlights included:

  • 21% of survey participants were aware of IFI
  • 7% of survey respondents planned to implement specific strategies to address IFI audit risk
  • 6% of survey respondents have received action alerts from CPA’s and tax attorney’s concerning IFI audit risk
  • 26% of survey respondents plan to alert fund investors to potential impact of IFI audit risk

Recommendations

Sum2 believes that survey results indicate extremely low awareness of IFI audit risk. Considering the recent trauma of the credit crisis, sensational fraud events and the devastating impact of last years adverse market conditions; fund managers and industry service providers must remain vigilant to mitigate this emerging risk factor. These market developments and the prevailing political climate surrounding the financial services sector will bring the industry under heightened scrutiny by tax authorities and regulatory agencies. Unregulated hedge funds may be immune from some regulatory issues but added compliance and disclosure discipline may be imposed by significant counter-parties, such as prime brokers and custodians that are regulated institutions.

Market and regulatory developments has clearly raised the tax compliance and regulatory risk factors for hedge funds and other fund managers. Issues concerning FAS 157 security valuation, partnership domiciles and structure, fund liquidation and restructuring and complex transactions has increased the audit risk profile for the industry. Significant tax liabilities, penalties and expenses can be incurred if this risk factor is not met with well a well considered risk management program.

In response to this industry threat, Sum2 has developed an IRS Audit Risk Program (IARP) that prepares fund management CFO’s and industry service tax professionals to ascertain, manage and mitigate its IRS risk exposures within the Three IFI Tiers.

The IARP provides a threat scoring methodology to ascertain risk levels for each IFI risk factor and aggregates overall IFI Tier exposures. The IARP uses a scoring methodology to determine level of preparedness to meet each of the 36 audit risk factors. The IARP helps managers to outline mitigation actions required to address audit risk factors and determine potential exposures of each risk. The IARP calculates expenses associated with mitigation initiatives and assigns mitigation responsibility to staff members or service providers.

The IARP links users to issue specific IRS resources, forms and documentation that will help you determine an IFI risk relevancy and the resources you need to address it. The IARP will prove a valuable resource to help you manage your response to a tax audit. It will also prove itself to be a critical tool to coordinate and align internal and external resources to expeditiously manage and close protracted audit engagements, arbitration or litigation events.

The IARP product is a vertical application of Sum2’s Profit|Optimizer product series. The Profit|Optimizer is a C Level risk management tool that assists managers to uncover and mitigate business threats and spot opportunities to maintain profitability and sustainable growth.

The IARP product is available for down load on Amazon.com.

The product can also be purchased with a PayPal account: Sum2 e-commerce

Sum2 wishes to thank all who anonymously took part in the survey.

If you have any questions or would like to order an IARP please contact Sum2, LLC at 973.287.7535 or by email at customer.service@sum2.com.

April 20, 2009 Posted by | FASB, hedge funds, IRS, legal, off shore, private equity, Profit|Optimizer, regulatory, reputational risk, risk management, Sum2, Tax, taxation | , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , | Leave a comment

IRS Has Hedge Funds in its Crosshairs

irs_logo-bwThe earths axis seemed to have tilted way off course last year. The global capital and credit markets crashed. Venerated banking institutions moved dangerously close to insolvency forcing mergers with better capitalized banks. The bulge bracket investment banking institutions disappeared. Some were acquired by traditional banks, others converted to a bank holding company structure; while others declared bankruptcy. In response the Federal Reserve, Treasury Department and SEC initiated unprecedented concerted interventionist actions. The passage of EESA legislation and the implementation of the $750bn TARP program are the first in many expected moves by the government to maintain the solvency of the banking system as a national economic security issue. In addition to these initiatives the government has also passed a massive $750bn economic stimulus bill to kick start the economy. All told over $1.5 trillion dollars has recently been appropriated by the federal government to address the economic crisis. This massive capital infusion has ratcheted up the federal budget deficit. It will be incumbent on the Treasury Department and the IRS to make a concerted effort to uncover new sources of revenue to finance these massive spending programs.

Hedge funds, private equity firms, CTA’s and other corporations that utilize elaborate corporate structures, engage in sophisticated transactions and recognize uncommon forms of revenue, losses and tax credits will increasingly fall under the considered focus of the IRS. Times have changed and so has the posture and practice of the IRS. The agency is transitioning its organizational posture by moving away from a benign customer service resource and assuming the form of an activist body that is intent on assuring compliance and enforcement of US tax laws. In particular it is building up its expertise and resource to more effectively address the audit challenges the complexity and sophistication hedge funds present.

The IRS has developed its industry issue competencies. It has developed a focused organizational structure that assigns issue ownership to specific executives and issue management teams. This vertical expertise is further enhanced with issue specialists to deepen the agencies competency capital and industry issue coordinators that lends administrative and agency management efficiency by ranking and coordinating responses to specific industry issues. Clearly the IRS is building up its portfolio of skills and industry expertise to address the sophisticated agility of hedge fund industry tax professionals.

To better focus the resources of the agency the IRS has developed a Three Tiered Industry Issue Focus. Tier I issues are deemed most worthy of in depth examinations and any fund management company with exposure in these areas need to exercise more diligence in its preparation and response. Tier I issues are ranked by the IRS as being of high strategic importance when opening an examination of hedge funds and other sophisticated corporate structures. This is followed by Tier II and Tier III focus areas that include significant examination issues but are ranked according to the agencies strategic significance of the market vertical. Clearly the IRS is investing significant organizational and human capital to address an industry that will no longer fly beneath the agencies radar. This institutional investment will be called upon to generate a considerable return on the investment in the hopes that the discovery of lucrative tax revenue streams will help to pay down the massive spending deficits of the federal government.

This development has clearly raised the tax compliance and regulatory risk factors for hedge funds and other fund managers. Significant tax liabilities, penalties and expenses can be incurred if this risk factor is not met with well a well considered risk management program. In response to this industry threat, Sum2 has developed an IRS Audit Risk program that allows a hedge fund CFO to quickly ascertain its IRS risk exposures within the Three Industry Focus Tiers.

The IRS Audit Risk program provides a threat scoring methodology to ascertain level of risk within each Tier item and aggregates overall Tier exposures. The product also uses a scoring methodology to determine your level of preparedness to meet the audit risk, mitigation actions required and potential exposures of the risk. The IRS Audit Risk calculates expenses associated with mitigation initiatives and assigns mitigation responsibility to staff members or service providers. The IRS Audit Risk links to issue specific IRS resources and documentation that will help you determine if the issue is a audit risk factor for your firm and the resources you will need to addresses it.

The IRS Audit Risk for Hedge Funds product is a vertical application of Sum2’s Profit|Optimizer product series. The Profit|Optimizer is a C Level risk management tool that assists managers to uncover and mitigate business threats and spot opportunities to maintain profitability and sustainable growth.

The IRS Audit risk for Hedge Funds product is available for down load on Amazon.com.

The product can be purchased here: Sum2 e-commerce

You Tube Music Video: Beatles, Taxman

Risk: tax liability, penalties, reputation

March 3, 2009 Posted by | compliance, EESA, hedge funds, IRS, legal, off shore, private equity, regulatory, reputational risk, risk management, SEC, TARP | , , , , | Leave a comment

SRZ’s Maginot Line

maginot_line_19441Schulte Roth Zabel’s (SRZ) Annual Private Investment Funds Seminar is the kick off event of the year for the AIM industry. In years past it was an event that was full of bravado from an industry flush with great expectations and giddiness over compensation levels that rivaled a small country’s GDP. This years event had more circumspection then bluster and more reflection on how to fashion a considered response to industry challenges squarely in the vortex of the market meltdown.

The shocking transformation and radical reconfiguration of the capital markets industry is underway. In the wake of the Lehman bankruptcy, Bear Stearns merger, market crashes, credit crisis, bank insolvency, recession and lastly the coup de grace of the Madoff scandal put these intrepid wealth managers through a trying year.

Myriad challenges and crises tested many firms management acumen and forced managers to work extra hard to earn that 2 and 20.  With hedge fund closure rates expected to approximate 25%-45% this year, the industry is confronted with enormous challenges. The excess capacity in the industry, heightened regulatory oversight, liquidity constraints and elevated client risk aversion will foster market compression and a dramatic alteration in market dynamics. The well managed, well positioned, well focused and well capitalized funds will thrive on the volatility. Uncertainty is always the mother of invention and the best and brightest of the breed will no doubt find numerous opportunities amidst the massive market dislocations currently underway.

SRZ a leading legal firm servicing the industry effectively laid out an industry battle plan to address many of these acute challenges. In the Crisis Management breakout session the panel offered an interesting metaphor of a hedge fund as an intricate and complex ecosystem. The topology of a fund complex is comprised of many parts that at times may have contradictory and competing interests.

The Crisis Management session conducted a quarterly review of market events that occurred in 2008 as the capital markets deteriorated and the credit crisis deepened. The panels review was an instructive exercise on how managers need to constructively engage problems with an intentional risk management program and how it affects each stakeholder in the hedge fund ecosystem. The principle objective was determining the best course of action to either save the fund or effect an orderly liquidation of the investment partnership. In all instances the strategy needed to consider how to serve the greatest good for all fund stakeholders. SRZ offered attendees a brilliant crisis management game plan for fund managers. It was one of the better presentations on risk management that I have ever attended.

The general session was also very interesting and engaging. The central theme was that hedge funds are under extreme liquidity pressure. The drivers are distressed portfolio valuations, counter-party deleveraging, risk aversion in the markets, market liquidity and increased redemption pressures from investors. SRZ has developed a series of innovative redemption strategies it calls gates. The gates are designed to protect the level of assets under management by controlling an orderly outflow of capital so as not to endanger the overall liquidity and asset level of the fund. SRZ again shows why it is the leading player in the space by offering innovative solutions to industry needs. A great example of a market leader demonstrating leadership by offering innovative product development solutions.

The overall tenor of the conference reminded me of the construction of the Maginot Line. In years past investors were eagerly throwing money at hedge fund mangers to get a slice of the alpha pie. Today hedge fund managers need to build sophisticated battlements to keep the assets of the investment partnership under their control. In a sense the industry as moved from an offensive posture to a defensive one. SRZ is assisting its hedge fund clients to create a defensible business structure that will protect the long term sustainability of the fund and ultimately serve the greatest good of the funds partners and stakeholders.

During these times of extreme market duress tactics and strategies must be employed to protect the fund from excessive redemption runs that would ultimately serve to create a self fulfilling prophesy of liquidation.

Clients who have access to a war council of professionals like SRZ should be well suited to engage the battles they will encounter in the coming year and survive to enjoy the peace and spoils won during the next business cycle.

You Tube Video: Edith Piaf, Mon Legionnaire

Risk: market, credit, legal, reputation

January 15, 2009 Posted by | hedge funds, legal, Madoff, risk management | , , , , , , , , , , | Leave a comment