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Healing the Breach: An Essay on Sound Practices for Fund Managers

…“the “money-management business” (with its plethora of mutual funds, investment counseling firms, and hedge funds) has so many practitioners who’ve grown up in an era where it’s all been about marketing and not risk management,…” “If 2004 goes bad, it will go really bad “ Bill Fleckenstein Contrarian Chronicle

This candid remark is an astonishing observation. The assertion that money management is more about marketing then risk management is a bit disconcerting. The most recent Security Exchange Commission’s (SEC) announcement concerning its investigations of brokerage firms for receiving commission payment premium’s by asset management firms for directing investors into purchases of preferred mutual funds is the latest example of how this statement is a tragic reality for investment product consumers.

We live in the era of radical capitalism. It is characterized by fierce political pronouncements of the sanctity of laissez-faire principles and the ultra aggressive pursuit of free markets, resulting in the increased rationalization of the market mechanism into our culture and daily lives. For many readers this statement is not surprising or profound. Marketing is king, and if you have any doubts about it, try locating a music station in New York City that is not wed to a Top 40 play list or Talk Radio format.

However, as this Milton Friedman vision of utopia continues its inexorable march of rationalization, a strange alchemy is taking place. As businesses damn the torpedoes to pursue markets, ethical business practices and sound corporate governance principles are being sacrificed at the alter of EBITDA, ROE, P/E’s and the Holy of Holies those sacred stock options. The ironic twist to all this is that these aggressive business practices defended on the grounds that they enhance shareholders value are actually seriously eroding the values of brands, profit margins and market capitalizations. Ask a shareholder of Enron, Parmalat or WorldCom about the clever corporate stewardship of these company’s former management teams and you’ll get a resounding thumbs down.

But there is something deeper going on here. When investors entrust their money to an investment manager, they may be attracted to the sizzle (remember past performance is not indicative of anything) but what they want is still the steak. Investors want an investment manager that can understand their investment goals and risk tolerance and provide them with an investment vehicle that can balance that risk tolerance with the capability of realizing an expected return. The act of giving a manager discretionary power over an individuals retirement fund, a union’s pension portfolio, a family office or child’s educational financing vehicle is a tremendous act of faith that requires an extraordinary degree of confidence in the manager’s ability to provide an acceptable return, but to also be a trusted fiduciary that has the requisite operational support and controls in place that will safeguard and honestly seek to grow and protect an investors capital.

Mr. Fleckenstein’s assertion that risk management has taken a back seat to marketing and product placement is unfortunately an accurate assertion. The financial services industry is unique in the sense that it is the loam of all capitalist constructs. Yet as a business, financial services companies are no different from any other economic enterprise. All companies create products and differentiate themselves through the value proposition incorporated into their product. Intrinsic to the product creation process is a determination of the type of materials that will form its composition. A conscious decision is made as to how the product will be positioned and marketed, its performance metrics determined, customer service resources required to support the product as consumers use it and how it will be distributed. Once those variables have been determined, a profit margin is added and a value proposition to potential customers is conveyed. The value proposition that is communicated to consumers comes to be known and identified as the product brand. An investment product is designed to essentially address current and future financing requirements and the risk profile of the consumer are central to the design and purpose of the product. That is why this bifurcation is so dangerous. It undermines the inherent purpose of the investment product and should more truthfully be marketed as a product that enriches the commission merchant that may over a specified period of time garner a return for the investor. Think about all the Enron employees who had their 401k’s invested entirely in Enron stock.

This is probably the most significant point and primal differentiator of companies that manufacture financial products with that of companies that manufacture consumer durables. Financial products facilitate the flow of capital through the markets. It feeds the invisible hand that guides and directs all economic activity. If the flow of financial products is impeded, or abates due to consumers lack of confidence, a consumer driven economy like that of the United States will suffer greatly. Foreign governments and institutions buy US Government bills, bonds and notes because of the well-earned confidence they have in Uncle Sam’s stable currency and it’s ability to pay it’s debt and provide a fair return to all note holders. However if that confidence goes away, Uncle Sam will have to curtail its deficit spending, raise taxes on its people and enter into other messy measures to remain economically viable. Confidence is a lovely thing both for nations and companies and once that confidence is lost it is a difficult, if not an impossible thing to regain. Confidence is the basis of risk management. Credit risk and rates of return, the key variables of risk management, all start with the certainty of confidence.

Yes, from an investment performance point of view 2003 was a terrific year. All major equity indices were up. Thanks in large part to a federal tax rebate program the US economy grew by 8% during the 3rd quarter, prompting Mr. Greenspan to proclaim with a certain degree of confidence that the recession had ended. Yet from corporate governance, business confidence point of view, 2003 business news makes the turn of the century robber barons look like acolytes of Mother Teresa. To restore confidence investment managers need to develop a Sound Practice program that will repair the breech and bridge the bifurcation of marketing and risk management within the investment management enterprise. Lets turn our focus on how and why this bifurcation must be bridged.

Sound Practices Builds Confidence

The explosive growth of the global hedge fund industry and the important role it plays in providing market liquidity and as an alternative asset class for high net worth investors and institutions is increasingly placing the industry in the global spotlight and many regulators, interest groups and institutional consumers are demanding greater transparency and advocating increased oversight and government regulation.

The Long Term Capital Management debacle, George Soros’s unilateral assault on and profitable dismantling of the Pre-Euro Exchange Rate Mechanism, numerous hedge fund blow-ups through poor management controls or outright fraud, and the most recent disclosure of the widespread collusion of hedge fund arbitrageurs and mutual fund managers to conduct market timing trading, is seriously eroding investor confidence in financial institutions. This is creating a political climate favorable to enhanced regulation and oversight of financial institutions. The recent investigative actions of New York State Attorney General Elliot Spitzer, and the appointment of William H. Donaldson to head the SEC are clearly political responses to the crisis in corporate governance and regulatory malfeasance.

At last count, there are approximately 20,000 companies engaged in investment management within the United States. Some investment companies are regulated by the SEC, some by the Commodities Futures Trading Commission (CFTC), some by the National Association of Securities Dealers (NASD), some conform to best practices required by custodial counter-parties, and some are guided solely by the good conscience of the fund manager.

In this rapidly expanding market, managers are seeking to differentiate themselves and attract investors assets through slick marketing campaigns, presentations, road shows, and shameless boasts about a mangers progeny, experience and past performance. Attestations of operational readiness and management’s commitment to ethical corporate governance is usually covered with a statement that lists the prime broker, the accounting firm for auditing and the administrator for transfer agency and shareholder communications. The manager believes that by listing the service providers (corporate brands) they convey a message to the investor that they are operationally sound and have the operational controls in place to satisfy all contingencies. Unfortunately, these service providers are retained for a very specific purpose and taken in aggregate do not amount to the implementation of a unified sound risk management program. Indeed, Arthur Anderson was a leading provider of services to the alternative investment management market and reliance on this brand to infer regulatory compliance or adherence to sound operational practices was clearly a miscalculation.

In the day-to-day operation of the business the tension between regulatory compliance and entrepreneurial zeal is usually resolved in favor of doing the transaction. When we asked an executing broker working a large sale transaction for a first time hedge fund customer if the hedge fund identity had been properly documented and verified in conformance with the rules of the USA PATRIOT Act he stated, “They’ll never answer these questions and if we ask they’ll simply go to another broker to work the order. We’ll take the hit to do the deal.” Yes this broker made a calculated decision based on the potential that the hedge fund was not entering into this transaction to launder money through the capital market system or was a front for terrorist financing. He was probably right, and earned his firm a nice commission for working the 100,000-share block at $.05 per share. But what if he was wrong? Was the premium commission rate a fair return for a ruined reputation, a million dollar fine, the revocation of your industry license, a lifelong ban from the industry, or even a prison sentence?

What are Sound Practices?

Sound Practices are a set of standards and operational controls that mitigate numerous risk factors in the investment management enterprise. Sound Practices address the investment process, its decision and operational support functions, capital introduction, compliance requirements, business continuity, fund strategies and investor communications within a set of defined expense ratios.

What’s the difference between Sound Practices and Regulatory Compliance?

If we accept the definition that compliance is a set of externally imposed rules required to insure that counter-parties of a transaction and the rules governing the transaction meet acceptable minimum standards to facilitate an ethical and efficient exchange of value; I think we come pretty close to the meaning and nature of compliance and the purpose of the functions required to support it.

In the United States, depending upon the type of products a financial services firm offers, there may be or may not be a governmental agency or Special Regulatory Organization (SRO) that is charged with compliance oversight and enforcement of its business practices. The Office of the Comptroller of the Currency (OCC) is charged with the responsibility to oversee compliance with regulatory statutes for savings and loans, thrifts and banks. For broker/dealers the NASD is the SRO oversight body. For mutual fund companies and publicly listed companies, the SEC is the regulator. Future Commission Merchants are regulated by the CFTC; and hedge funds, -sometimes referred to as an Unregistered Investment Company (UIC)- at present escape any formalized regulatory oversight body.

Each regulatory body has its own set of compliance rules, guidelines and enforcement mandates. One can imagine the overlap and confusion that occurs when a bank owns a broker dealer, which owns an asset management firm, that offers mutual funds and off shore hedge fund products to institutional, retail and high net worth investors. The maze of regulators and the differing and sometimes contradictory regulatory requirements creates a reactionary and possibly antagonistic response to regulatory examinations and demands. At the very least, compliance is a significant cost of doing business and adds little to the intrinsic value of the product offered by the institution. The added expense of compliance deals with the structural aspects of the market, not the intrinsic value of the product. This is a dangerous bifurcation in its own right. A financial product, (specie for the capital markets) requires a denigration of value to assure a controlled velocity through a regulated market structure.

For companies that view regulatory compliance as a necessary evil that tempers entrepreneurial pursuits and whose function is an added cost of doing business; these organizations will develop a best practice culture that is inherently restrictive. This type of corporate response to regulatory or best practices initiatives will always be overwhelmingly reactive and places the enterprise at great operational and regulatory risk.

Sound Practices are different. Sound practices are a set of internally (organically) developed operating principles that inform the values of ethical corporate governance, is enforced by internal management and seeks to become invisible as it ingrains itself into the operational and business culture of the firm. Sound practices must be viewed as fundamental to a firm’s value proposition, organically grown and endemic to the corporate culture and proactively conveyed to the market as a premium brand.

The internal development or organic growth of best practices as a central desire and objective of the corporate enterprise is revealed as central to product brand and the value proposition offered in the market. This positions the firm and its products as a premium brand. The business benefits of a sound practice program are enhanced margins, product performance and the attraction of quality clients and vendor relationships. More importantly it differentiates the firm in a crowded market because its quality brand is perceived by the market as endemic to the firm’s corporate culture and as such is inherently superior to something that is externally imposed by some governmental or regulatory body. On a macro-economic level the socialist or state capitalist experiments in highly regulated planned economies are the logical extreme and true antithesis of a sound practice culture.

Within the hedge fund industry in the United States the concept of Sound Practices first surfaced in an industry study entitled Sound Practices for Hedge Funds. The study was an industry response to the Clinton Administration’s request to examine the lessons learned from the Long Term Capital Management implosion and recommend basic guidelines to avoid similar disastrous occurrences in the future. The paper was a breakthrough on a number of fronts, placing the science of risk management and the utilization of risk measurement tools at the center of the investment management enterprise. Though the study was a political response to a catastrophic market event, the real purpose of the study was to temper the drive to regulate the hedge fund industry. In essence, the authors of the study asserted that regulatory oversight is not needed if hedge funds implement and maintain a sound practices program. Sound practices will allow investment companies to remain unregulated and will assure that the industry is fully capable of self-policing through the creation of practice standards. Indeed, any regulation or governmental oversight will further drive the industry offshore to more discreet and tax friendly domiciles and could potentially drain capital and liquidity from the US capital markets.

Operational Risk Mitigation

As previously stated, developing and adhering to a set of best practices principals and guidelines will add intrinsic value to product and corporate brand. The purveyors of Business Performance Management (BPM) solutions routinely boast the claim that publicly listed companies that practice BPM have P/E ratios that trade at a 15% premium to industry peers who have not implemented a BPM strategy. The question whether BPM is a silver bullet to enhance market value or whether BPM practitioners are leading companies dedicated to implementing programs and mechanisms to build shareholder value are irrelevant. What is important is that BPM practitioners are implementing processes and tools to understand and isolate operational risk to create product delivery and decision support mechanisms that build intrinsic product and corporate brand value. Thus at its heart, BPM practitioners seek to heal the bifurcation of marketing and operational risk management and firmly establish and display the synthesis as central to the value proposition a company delivers to its clients.

Operational risk factors in the investment management complex are numerous. They include valuation practices, system infrastructure, business continuity contingencies, vendor and service provider dependencies, risk management tools, risk management function segregation and asset gathering or capital introduction and investment acceptance principles. All of these risk factors are significant and each one on its own could threaten the ongoing viability of the enterprise. Each risk factor must be addressed in detail with a comprehensive programmatic approach to develop and implement processes and controls to enhance best practices to support the function and mitigate the risk factor associated with the business process. The Basel Capital Accord (Basel ll) proposes the introduction of a capital charge related to the operational risks of financial institutions. Basel II defines operational risk as “the risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems or from external events.”

As an example, poor record keeping or an honest miscalculation on a corporate action treatment or security valuation can be forgiven. After all, the restatement of earnings -even during the Sarbanes Oxley Era- in corporate America is common. Laundering money for criminal enterprises, or heaven forbid, financing terrorism goes way past lax controls. In the eyes of the law it is criminal, in the eye’s of regulatory authorities it’s a serious offence, and a heavy fine and asset forfeiture is possible. If this occurs, in the mind of the consumer the fund manager is guilty of two counts of treason. The first count of treason the fund manger is guilty of is against his country. The second count the fund manager is guilty of is the betrayal of a sacred fiduciary duty. A hedge fund manager would probably never recover from this type of avoidable catastrophic risk event.

Fund managers need not look at compliance with the USA Patriot Act as another cumbersome compliance requirement that will be expensive to address. The belief that compliance will antagonize or annoy potential clients and may in fact drive them to a competitor whose controls are not as stringent and whose compliance laxity facilitates transactions by making it easier for investors to place assets with the competitor may hold some truth. But shouldn’t a fund manager avoid those types of clients anyway?

Compliance with The USA Patriot Act requires that investment companies conduct due diligence and maintain and administer a Customer Identification Program (CIP). Investment companies should view compliance with the Act as an opportunity to develop a Know Your Customer (KYC) capability that enhances and enriches the client relationship with the firm. When fund managers make KYC the cornerstone of their product development initiatives marketing will then truly serve the risk management requirements of clients.

The process of conducting the KYC due diligence exercise results in a more in-depth understanding of the customer. As managers are verifying customer identification information they will routinely uncover residential, employment and family histories that give them a better perspective on the client’s needs, their appetite for risk, other fiduciary relationships the client has and the source of the clients wealth. The regulatory objective of the KYC process is to verify the clients identity and to make sure they are not a money launderer or terrorist. The sound practice objective of the KYC process is to cover the regulatory requirements and more importantly to gain insights and understandings into their personal and business motivations. Armed with this understanding the manager can design or offer an investment product that will address the client’s risk management requirement. Client’s will appreciate the fact that managers are conducting this due diligence to insure that their funds will not be commingled with money launderers or terrorists, and that the firm is taking appropriate steps to insure that they transact business with reputable clients whose ethical and moral standards are similar to their own high standards.

As clients experience the KYC discovery process, they will begin to understand that the firm is committed to delivering a qualitatively superior value proposition. The client experience will help them to understand that the marketing focus of the firm is to acquire trusted customers and the depth and quality of client relationships are established to understand client needs and requirements. The client will also gain the assurance that regulatory risk and the potential for large fines and asset forfeitures are minimized due to the care the firm has exercised in determining that its clients are the right type of clientele and that the firm’s management has created operational controls and processes to prevent the risk of money laundering within the investment management enterprise.

Furthermore, subscription and redemption releases are facilitated due to proper controls in place with administrators and custodial institutions. This places enhanced liquidity at a fund manager’s disposal allowing the manager to practice effective cash management techniques that position the manager to take advantage of investment opportunities that may arise. This raises the possibility of developing a more effective collateral management capability that will tighten spreads on haircuts and dramatically reduce financing expenses. The credit rating of the firm would improve allowing lenders to further reduce financing rates to capture the funds business in a competitive credit and financing market. The reduction in the cost of capital can dramatically affect investment performance and the marketers can truly boast of a source of alpha that is directly attributable to operational sound practice processes.

Having proper procedures and business processes in place with administrators and custodian institutions will also facilitate the transfer of shareholder data to accountants for tax and audit purposes. This will expedite the delivery of tax and performance information to shareholders, generating savings in preparation fees and lessening the possibility of costly restatements. This will reduce and maintain fund expense ratios to absolute minimums. Marketers can clearly demonstrate that the fund managers are good stewards and are as concerned with minimization of business expenses as well as investment performance and high watermarks.

Increased transparency and the opportunity to dramatically enhance shareholder communications and reporting will be a strong attraction to many investors. Indeed, many institutional investors demand a level of transparency, communication protocols, and reporting tools that would have been unthinkable only a short while ago. As sophisticated institutional participation grows within the industry, the implementation of a sound practice program will be the only way hedge fund products can incorporate the necessary value proposition that addresses their risk management profiles and requirements. Sound practices and the compliance function become significant differentiators and powerful marketing tools. At last, the bifurcation is healed.

James Wolfensohn, President of the World Bank has been quoted as saying, “Corporate governance is about promoting corporate fairness, transparency and accountability.” Sound Practices is a necessary prerequisite for effective and ethical corporate governance. Fund managers must accept it’s precepts and sell side institutions and other industry participants and service providers must demand compliance, disclosure, ethical trading principals, honest research, operational integrity and a full commitment to its implementation and adherence. Effective corporate governance practices will restore the faith of the investing public in the global financial services industry and maintain the rationality of the world’s capital markets. It will also please investors to see realized enhanced returns on investment portfolios and help fund managers to fully participate and enjoy the benefits of a thriving hedge fund practice.

Originally written January 5, 2004, the article is significant because it raises concerns about financial services product marketing practices that still need to be addressed six and half years later.

You Tube Music Video: Mike Oldfield, Tubular Bells

Risk: regulatory, consumer confidence, sound practices

June 7, 2010 Posted by | AML, banking, Basel II, credit crisis, hedge funds, investments, marketing, operations, private equity, product, product liability, regulatory, reputational risk, risk management, sound practices | , , , , , , , , , , , , , , , , , , , , | 1 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

Goldman Sachs as Social Entrepreneur

Goldman Sachs’ CEO Lloyd Blankfein and his largest investor, The Wizard of Omaha, Warren Buffett , descended from the mystical heights of Valhalla with some startling news.  They were bearing a new mythical golden ring.  As they held the ring aloft they made a bold proclamation.  They would embark on one of the grandest social entrepreneurial programs of all time by offering some of the rings precious power, about $500 million worth, to capital starved small and mid-size enterprises (SMEs).  The 10,000 Small Businesses Initiative will distribute $100 million per year over the next five years to SMEs through Community Development Financial Institutions.

These lords of commerce have heard the cries from endangered SMEs.  In their infinite wisdom Blankfein and Buffet understand that the real economy needs to resuscitate and incubate the critical SME segment as an absolute prerequisite to a vibrant economic recovery.    The buzz about this news in the marketplace ranged from cynical suspicion at one extreme to puzzled bemusement and  ecstatic aplomb at the other.

What motivated Goldman to announce this initiative is an interesting question.  Was it guilt, greed or a sense of corporate social responsibility?  Some suggest it is a master PR move to counter a growing public perception that Goldman Sachs,  the poster child of government favoritism and bailout largess,  has leveraged its unfair advantage to achieve historic levels of profitability.  Thus enabling management to pay obscene bonuses to company employees.  But capital has no psyche,  and half a billion dollars is a tall bill to underwrite absolution for some phantom form of guilt.  True to its nature, capital always  seeks a place where it will find its greatest return.  Goldman and Buffett are casting some major bread on the receding waters of a distressed economy.  As its foretold in the Good Book , doing God’s work will produce a tenfold return.  If the Bible’s math is correct, thats a lot of manna that will rain down from heaven for the shareholders of Goldman Sachs and Berkshire Hathaway.  Looks like our modern day version of Moses and Aaron have done it again.  Leading their investors across the dangerous waters of the global economy to live in the promised land of happy shareholders.

As one of the world’s preeminent investment banks and purveyor of capitalist virtues,  company shareholders must be questioning how Goldman’s managers will realize a return on this investment?  Has management examined the potential corporate and societal moral hazards surrounding the program?  Surely shareholders have asked when they expect to be compensated for this significant outlay of capital.   The desire to realize gain is a more plausible motivator and makes more sense for an enterprise like Goldman and the storied investment Wizard from Omaha.

Its wise to ascribe the best intentions and virtuous motivations to actions that we may not fully understand.  This program should be viewed as a seminal event in the history of corporate social responsibility and social entrepreneurship.  Its important to understand that institutions that practice corporate social responsibility do not engage it solely as a philanthropic  endeavor.  Indeed, the benefits of good corporate citizenship pays multidimensional dividends.  All ultimately accrue to the benefit of company shareholders and the larger community of corporate stakeholders.

Goldman’s  move to walk the point of a capital formation initiative for SMEs seeks to mitigate macroeconomic risk factors that are prolonging the recession and pressuring Goldman’s business.   Goldman needs a vibrant US economy if it is to sustain its profitability,  long term growth and global competitiveness.  Goldman needs a strong regional and local banking sector to support its securitization, investment banking and corporate finance business units.   Healthy SMEs are a critical component to a healthy commercial banking sector.  Goldman recent chartering as an FDIC bank holding company may also be a factor to consider.  This SME lending initiative will provide interesting insights into the dynamics of a market space and potential lines of business that are relatively new to Goldman Sachs.  This initiative might presage a community banking acquisition program by Goldman.  At the very least the community banking sector is plagued with over capacity is in dire need of rationalization.  Goldman’s crack team of corporate finance and M&A professionals expertise would be put to good use here.

Goldman’s action to finance SMEs will also serve to incubate a new class of High Net Worth (HNW) investors.  Flush with cash from successful entrepreneurial endeavors, the nouveau riche will be eager to deploy excess capital into equities and bonds, hedge funds and private equity partnerships.  Healthy equity markets and a growing Alternative Investment Management  market is key to a healthy Goldman business franchise.

Community banks, principal lenders to SMEs are  still reeling from the credit crisis are concerned about troubled assets on their balance sheets.  Bankers can’t afford more write downs on non-performing loans and remain highly risk adverse to credit default exposures.  Local banks have responded by drastically reducing credit risk to SMEs by curtailing new lending activity.  The strain of a two-year recession and limited credit access has taking its toll on SMEs.  The recession has hurt sales growth across all market segments causing SMEs to layoff employees or shut down driving unemployment rates ever higher.  Access to this sector would boost Goldman’s securitization and restructuring advisory businesses positioning it to deepen its participation in the PPIP and TALF programs.

The financial condition of commercial and regional banks are expected to remain stressed for the foreseeable future.  Community banks have large credit exposures to SME and local commercial real estate.  Consumer credit woes and high unemployment rates will generate continued losses from credit cards and auto loans.  Losses from commercial real estate loans due to high vacancy rates are expected to create significant losses for the sector.

Reduced revenue, protracted softness in the business cycle and closed credit channels are creating perfect storm conditions for SME’s. Bank’s reluctance to lend and the high cost of capital from other alternative credit channels coupled with weak cash flows from declining sales are creating liquidity problems for many SMEs.   Its a growing contagion of financial distress.  This contagion could infect Goldman and would have a profound impact on the company’s financial health.

The 10,000 Businesses  initiative will strengthen the free flow of investment capital to finance national economic development and empower SMEs.  It strengthens free market capitalism and has the potential to pool, unleash and focus investment capital into a strategic market segment that has no access to public equity and curtailed lines of traditional bank credit. The 10,000 Businesses initiative  will encourage wider participation by banking and private equity funds.  In the aggregate, this will help to achieve strategic objectives, build wealth and realize broader goals to assure sustainable growth and global competitiveness.  All to the benefit of Goldman Sachs’ shareholders and it global investment banking franchise.

Sum2 believes that corporate social responsibility is a key tenet of a sound practice program. Goldman Sach’s has always been a market leader.  We salute Goldman Sachs’ initiative and welcome its success.

In  September of 2008,  Sum2 announced The Hamilton Plan calling for the founding of an SME Development Bank (SDB).  The SDB would serve as an aggregator of capital from numerous stakeholders to focus capital investment for SME manufactures.   More on the Hamilton Plan can be read here: SME Development Bank.

Risk:  SME, bank, recession, unemployment, credit, private equity

You Tube Music: 10,000 Manaics, Natalie Merchant: Dust Bowl

November 20, 2009 Posted by | banking, corporate social responsibility, Hamilton Plan, hedge funds, investments, off shore, PPIP, private equity, Profit|Optimizer, recession, reputation, reputational risk, SME, sound practices, Sum2, TALF, unemployment | , , , , , , , , , , , , , , , , , , , , , , , , , , , , , | Leave a comment

A Taxing Situation

irs-and-capitol2President Obama announced his intention to curb the use of offshore tax havens for multinational corporations.  The Treasury Department is looking to raise tax revenues and believes that by closing the use of offshore tax shelters it will be able to raise over $200 bn over the next ten years.  According to the New York Times,  firms like Citibank, Morgan Stanley, GE and Proctor and Gamble utilize hundreds of these type structures to shelter revenue from being taxed by the IRS.  It has effectively driven down the tax rates these companies pay and has been a key driver in maintaining corporate profitability.

This move should come as a surprise to no one.  The Treasury Department needs to find sources of tax revenues to cover the massive spending programs necessitated by the credit crisis and the global economic meltdown.  The TARP program designed to revitalize banks has  expenditures that amounted to $700 bn.  Amounts pledged for economic recovery through EESA, PPIP and ARRA will push Treasury Department expenditures targeting economic stimulus projects and programs to approximately $2 tn.  These amounts are over and above routine federal budget expenditures that is running significant deficits as well.

The planned move by the Treasury Department to rewrite the tax code may be an intentional effort to close budget deficits but it also represents a significant rise in tax audit risk.   For the past two years the IRS has been developing a practice strategy and organizational assets to more effectively enforce existing tax laws.  Private sector expertise, practices and resource has significantly out gunned the IRS’s ability to detect and develop a regulatory comprehension of the tax implications of the sophisticated multidomiciled structured transactions flowing through highly stratified and dispersed corporate structures.  The IRS is looking to level the playing field by adding to its arsenal of resources required to engage the high powered legal and accounting expertise that corporate entities employ.

The IRS has hired hundreds of new agents  and has developed risk based audit assessment guidelines for field agents when examining corporations with sophisticated structures and business models.  As such investment partnerships, global multinational corporations and companies utilizing offshore structures can expect to receive more attention from IRS examiners.

The IRS had developed Industry Focus Issues (IFI) to be used as an examination framework to guide audit engagements for sophisticated investment partnerships and  Large and Mid-size Businesses (LSMB).  The IFI for LSMB has developed three tiers of examination risk.  Each tier has comprises about 12 examination issues that will help examiners focus attention of audit resource on areas the agency considers as high probability for non-compliance.  Clearly the audit risk factors risk

To respond to this challenge, Sum2 developed an audit risk assessment program to assist CFO’s, tax managers, accountants and attorneys conduct a through IFI risk assessment.  The IRS Audit Risk Program (IARP) is a mitigation and management tool designed to temper the threat of tax audit risk.   A recent survey commissioned by Sum2 to measure industry awareness of IFI risk awareness indicated extremely low awareness of tax audit risk factors.

Sum2’s IARP helps corporate management and tax planners score exposure to each IFI risk factor.  It allows risk managers to score the severity of each exposure, mitigation capabilities, mitigation initiatives required to address risk factor, responsible parties and mitigation expenses. The IARP allows corporate boards and company management to make informed decisions on tax exposure risk, audit remediation strategies, arbitration preparation and tax controversy defense preparation.

The IARP links to all pertinent IRS documentation and information on each tax statute and IFI audit tier.  The IARP links to pertinent forms and allows for easy information retrieval and search capabilities of the vast IRS document libraries.  The IARP also has links to FASB to have instant access to latest information on accounting and valuation treatments for structured instruments.

The IARP is the newest risk application in the Profit|Optimizer product series.  The Profit|Optimizer is a enterprise risk management tool used by SME’s and industry service providers.

The IARP is available in two versions.

The IRS Audit Risk Program for investment partnerships (IARP)

Buy it on Amazon here: IARP

The Corporate Audit Risk Program (CARP)

Buy it on Amazon here: CARP

Sum2’s Audit Risk Survey results are here: IFI Audit Risk Survey

You Tube Video: Chairman of the Board, Pay to the Piper

May 7, 2009 Posted by | business, commerce, economics, EESA, FASB, government, hedge funds, IRS, off shore, Profit|Optimizer, regulatory, SME, TARP, Tax, taxation, Treasury | , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , | Leave a comment

Intellectual Capital Deflation

balloonBearingPoints Chapter 11 filing represents a watershed type event.

The filing by the global consulting firm BearingPoint puts it on life support or at the very least in an intensive care unit. BearingPoint the bulge bracket consulting firm that was spun off from KPMG due to regulatory mandates concerning the separation of accounting and advisory businesses is in serious trouble. It has been struggling under a mountain of debt and the bankruptcy filing will give the firm protection from creditors while it seeks to reorganize its business.

BearingPoint’s filing is an interesting metaphor about the deflation of intellectual capital.  Ideas, creativity, knowledge, productivity and innovation are some of the words that that we closely associate with intellectual capital.  Once we may have even thought this form of capital to be immune from the vicissitudes of the banality of markets.  I surmise that the recent business cycle exposes that idea as based more in our narcissistic prejudices then the cold objective realities of efficient markets.  As we witnessed radical capitalism’s continued drive of extreme rationalization through monetization we discovered the price of anything but seriously lost sight of the value of everything.

During the 1990’s I remember always being impressed and astonished by the reports of the rising productivity of the American workforce.  Year in year out the rising productivity was the proud boast and confirmation of American managerial brilliance.  But today that claim looks spurious at best.  Rethinking this proclamation may reveal this was accomplished not by brilliant management innovation but by outsourcing operational functions to subsistence based economies; and some artful balance sheet wizardry that aligned business performance ratios to maximize shareholder returns; particularly senior managers whose stock options were critical design considerations as to how those ratios were engineered.  Indeed if productivity is a proxy for innovation, the productivity of  American capitalism was outpacing the most aggressive predictions of Moore’s Law.  True technology contributed to massive gains in productivity but in many ways was an economic rent seeking agent that enabled a flawed economy to sustain itself through over leveraged economic and misdirected intellectual capital.

Today we are confronted with the evaporation of massive social wealth that the IMF estimates to be almost $4.1 trillion in the financial service sector.  I suspect a good portion of this value was carried on the balance sheet as good will.  And anyone that has been living close the plant earth the past couple of years can attest to how the good will of corporations has been severely discounted.  Perhaps this wealth never really existed and as the saying goes “you can’t lose what you never had”.  We can take comfort in that and perhaps we can look on the bemused folly of central governments eagerly trying to stimulate economic growth to levels of our recent unsustainable past.  I must admit that my sympathies and conviction stand with the Keynesian but I am beginning to wonder if they are chasing the long tails of ghostly economic shadows cast by AIG’s worthless CDS franchise.  Once considered a revolutionary innovation cooked up by the finest minds of the capital markets financial engineers are now perplexing conundrums wrapped in a riddle and remain valuation Level Three FAS 157 mysteries.

To be sure intellectual capital deflation is a huge subject.  I must also admit that this blogger lacks the time, skill and brain power to elucidate and articulate the numerous nuances and depth this assertion deserves and requires.  I guess we could sum it up in a sound bite like the “dumbing down of America” but I believe that merely addresses the race to the bottom marketers skillfully cultivated to gobble up a greater portion of that ever fickle and fluid market share pie.  In a way the deflation we speak of turns this dumbing down on its head and now claims the purveyors of fine ideas and clever tactics devised by the corporate marketing geniuses who were able to enrich themselves by conceiving the brilliant plans to convince us to buy so they can sell as much useless junk to as many people as possible.

The monetization of intellectual capital by incorporated consultants are increasingly becoming inefficient.  New technologies that are enablers of strategic thinking has large consultancies disappearing into the computing cloud.  Large bull pens of gray matter are inefficient as innovation in small firms are more efficient purveyors of thinking large to solve small problems or thinking small to solve larger problems. The large corporate dinosaurs that protected bloated bureaucracies enmeshed in group think stasis increasing showed an inability to be agents of innovation.  They boldly proclaimed best practices to justify and position themselves in the executive office but now that the large corporations have been decapitalized their value creation mantras dissipated as markets capitalization fell.

In appears that the bulge bracket firms viability were dependent on knowledge transfer initiatives to underdeveloped economies to support outsourcing; and rent seeking business models dependent on regulatory mandates of Sarbanes Oxley, GBLA, COBIT, EURO conversions, Basel II, Y2K, PATRIOT ACT, HIPAA, FISMA etc etc. Their business models profited from significant business drivers of the past two decades the reallocation of capital to emerging markets and the guarantee of market protection due to governmental regulatory mandates.  In both instances value creation from the deployment of intellectual capital proved to be unsustainable.

Consider the financial services industry and hedge funds.  Hedge funds claim to offer uncorrelated investment products but most of the hedge funds performance fell in lock step with the market index averages.  Investors pay premiums to participate in absolute return strategies offered by hedge funds.  Fund managers make the claim of absolute returns based on their superior insights that their intellectual capital confers on their investment strategies.  Last year that claim was demolished to devastating effect.

Newspaper publishers are also experiencing a decline in the portfolio value of their intellectual capital.  But many believe that it is more of  a question of their antiquated business model and once they figure out how to Googlize their business model to sufficiently monetize its intellectual capital shareholders will once again be rewarded with an appreciation in its investment and the true value of their intellectual capital will be realized.

The markets are dramatically changing. Today the question is not so much about ideas and strategy its a question of execution. Just as in the recent past it was about raising capital and acquiring assets now its about making informed capital allocation decisions and liquidity. Its true you need the target to shoot at but you also need munitions, a good scope with adjusted cross hairs and a gun. The value proposition of consultants is quickly becoming marginalized.

Its a poor business model. It scales poorly, its racked with inefficiencies, its built on protected markets and knowledge segregation. Now that those barriers are falling and more and more MBAs are out of work the value of this form of intellectual capital continues to fall.

Consultants all to often are beholden to their process biases. They find it difficult to get out of the box and routinely ask their engagements to climb into the box with them. That said it is an absolute necessity that business redefines its business model to address current market realities. It needs to do so with dispassionate dispatch and it needs to create a unique value proposition that differentiates the brand and adds identifiable alpha in an expanded value delivery chain.

Its a big challenge that many professional services firms need to confront. Our firm went through that transition 6 years ago. We went from a strategic sound practices consulting firm to a product creation and marketing firm dedicated to the commercial application of sound practices. For Sum2 creating value was a very different value proposition then delivering value. The need to build equity in our business was our principal concern. Building and marketing tangible product value is how you create a sustainable business model.

Corporations are becoming disenthralled of their self perceived cleverness. Many believe that major investments in applied intelligence create a culture of insularity that hedges all risks and builds enterprise value. In the past it allowed executives to hide behind a wall of opaqueness. They bought the best and brightest minds from our esteemed business schools convinced that this treasure of intellectual capital would protect them. They believed the digital blips of risk models to be sparkling Rosetta Stones containing the secrets that unlock the mysteries of effective risk management, value creation and business sustainability. The codified results of these algorithmic exercises are revered as holy Dead Sea Scrolls that offers the protection of an supernatural mojo. This is the thinking of a bankrupt brain trust.

You Tube Video: Nena, 99 Luft Ballons

Risk: Group Think, sustainable business model, value creation

April 24, 2009 Posted by | banking, bankruptsy, Basel II, business continuity, economics, FASB, investments, media, risk management, Sum2 | , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , | 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 Audit Risk Survey for Hedge Funds (Interim Update 3)

irs-and-capitol21The IRS has developed a methodology to determine an audit risk profile for hedge funds, private equity firms, CTAs, RIAs and corporations using offshore structures. Sum2 has commissioned a survey to determine financial services industry awareness and readiness for IRS audit risk factors.

The survey seeks to determine industry awareness of IRS Industry Focus Issue (IFI) risk exposures for hedge funds, private equity firms, RIAs, CTAs and corporations using offshore structures. The survey is open to fund management executives, corporate treasury, tax managers and industry service providers.

CPAs, tax attorneys, compliance professions, administrators, custodians and prime brokers are also welcomed to participate in the study. The study’s purpose is to determine the level of industry preparedness and steps fund managers are taking to mitigate potential exposures to IFI audit risk.

Sum2 will share weekly interim results of the surveys findings. The survey will run for four weeks. This is the second weekly report.

Survey Highlights

  • 76% of survey respondents are from North America
  • 6% are from Great Brittan
  • 13% are from other EU countries
  • 5 % are from Asia
  • 85% of respondents indicate an unawareness of IFI
  • 11% of respondents indicate they plan to alert investors to IFI impact
  • 10% of respondents indicated that they initiated actions to address IFI
  • 8% of respondents indicated that they have received action alerts from industry service providers

    Take the Survey

    We invite you to participate in a survey to determine industry awareness of IRS Industry Focus Issue risk for hedge funds, private equity firms, RIAs, CTAs and offshore corporate structures.

    The survey can be accessed here: IRS Audit Risk Survey for Hedge Funds

    The survey is open to fund management executives and industry service providers to the industry. CPAs, tax attorneys, compliance professions, administrators, custodians, consultants and prime brokers are welcome to take the study. The study’s purpose is to determine the level of industry preparedness and steps fund managers are taking to mitigate potential exposures to IRS Industry Focus Issue risk.

    Sum2 is looking to use the survey to better respond to the critical needs of fund managers and the alternative investment management industry by improving our just released IRS Audit Risk Program (IARP).

    This survey asks ten questions. The questions concern your awareness of IFI and how it pertains to your fund or fund management practice.  The survey seeks to determine overall industry risk awareness, potential exposure to IFI risk factors and any mitigation initiatives you plan to address IFI risk factors.

    It should take no more then 5 minutes to complete the questionnaire. Your participation in this study is completely voluntary. There are no foreseeable risks associated with this project. However, if you feel uncomfortable answering any questions, you can withdraw from the survey at any point. It is very important for us to learn your opinions. Your survey responses will be strictly confidential and data from this research will be reported only in the aggregate. Your information will be coded and will remain confidential.

    If you have questions at any time about the survey or the procedures, you may contact Sum2 at 973.287.7535 or e-mail us at customer.service@sum2.com

    Thank you for your participation.

    March 29, 2009 Posted by | compliance, hedge funds, IRS, risk management, taxation | , , , , , , , , , , | Leave a comment

    IRS Audit Risk Survey for Hedge Funds (Interim Update 2)

    irs-and-capitol2The IRS has developed a methodology to determine an audit risk profile for hedge funds, private equity firms, CTAs, RIAs and corporations using offshore structures. Sum2 has commissioned a survey to determine financial services industry awareness and readiness for IRS audit risk factors.

    The survey seeks to determine industry awareness of IRS Industry Focus Issue (IFI) risk exposures for hedge funds, private equity firms, RIAs, CTAs and corporations using offshore structures. The survey is open to fund management executives, corporate treasury, tax managers and industry service providers.

    CPAs, tax attorneys, compliance professions, administrators, custodians and prime brokers are also welcomed to participate in the study. The study’s purpose is to determine the level of industry preparedness and steps fund managers are taking to mitigate potential exposures to IFI audit risk.

    Sum2 will share weekly interim results of the surveys findings. The survey will run for four weeks. This is the second weekly report.

    Survey Highlights

    • 65% of survey respondents are from North America
    • 15% are from Great Brittan
    • 12% are from other EU countries
    • 3% are from Asia
    • 78% of respondents indicate an unawareness of IFI
    • 18% of respondents indicate they plan to alert investors to IFI impact
    • 17% of respondents indicated that they initiated actions to address IFI
    • 11% of respondents indicated that they have received action alerts from industry service providers

    Take the Survey

    We invite you to participate in a survey to determine industry awareness of IRS Industry Focus Issue risk for hedge funds, private equity firms, RIAs, CTAs and offshore corporate structures.

    The survey can be accessed here: IRS Audit Risk Survey for Hedge Funds

    The survey is open to fund management executives and industry service providers to the industry. CPAs, tax attorneys, compliance professions, administrators, custodians, consultants and prime brokers are welcome to take the study. The study’s purpose is to determine the level of industry preparedness and steps fund managers are taking to mitigate potential exposures to IRS Industry Focus Issue risk.

    Sum2 is looking to use the survey to better respond to the critical needs of fund managers and the alternative investment management industry by improving our just released IRS Audit Risk Program (IARP).

    This survey asks ten questions. The questions concern your awareness of IFI and how it pertains to your fund or fund management practice.  The survey seeks to determine overall industry risk awareness, potential exposure to IFI risk factors and any mitigation initiatives you plan to address IFI risk factors.

    It should take no more then 5 minutes to complete the questionnaire. Your participation in this study is completely voluntary. There are no foreseeable risks associated with this project. However, if you feel uncomfortable answering any questions, you can withdraw from the survey at any point. It is very important for us to learn your opinions. Your survey responses will be strictly confidential and data from this research will be reported only in the aggregate. Your information will be coded and will remain confidential.

    If you have questions at any time about the survey or the procedures, you may contact Sum2 at 973.287.7535 or e-mail us at customer.service@sum2.com

    Thank you for your participation.

    March 22, 2009 Posted by | hedge funds, IRS, off shore, private equity, Tax | , , , , , , , , | Leave a comment

    IRS Audit Risk Survey for Hedge Funds Interim Results

    sum2logoThe IRS has developed a methodology to determine an audit risk profile for hedge funds, private equity firms, CTA’s RIAs and corporations using offshore structures.

    Sum2 has commissioned a survey to determine financial services industry awareness and readiness for IRS audit risk factors.  The survey seeks to determine industry awareness of IRS Industry Focus Issue (IFI) risk exposures for hedge funds, private equity firms, RIAs, CTAs and corporations using offshore structures.

    The survey is open to fund management executives, corporate treasury, tax managers and industry service providers. CPAs, tax attorneys, compliance professions, administrators, custodians and prime brokers are also welcomed to participate in the study.

    The study’s purpose is to determine the level of industry preparedness and steps fund managers are taking to mitigate potential exposures to IFI audit risk.

    Sum2 will share weekly interim results of the surveys findings.  The survey will run for four weeks.  This is the first weekly report.

    Survey Highlights

    • 62% of survey respondents are from North America
    • 18% are from Great Brittan
    • 16% are from other EU countries
    • 4% are from Asia
    • 50% of respondents who viewed survey begin survey
    • 20% of respondents indicate an awareness of IFI
    • 9% of respondents indicated that they initiated actions to address IFI
    • 7% of respondents indicated that they have received action alerts from industry service providers concerning IFI
    • 2% of respondents indicated that they plan to communicate impact of IFI to fund investors

    We invite you to participate in a survey to determine industry awareness of IRS Industry Focus Issue risk for hedge funds, private equity firms, RIAs, CTAs and offshore corporate structures.

    The survey can be accessed here:  IRS Audit Risk Survey for Hedge Funds

    More information and alerts can be found here:  Credit Redi

    The survey is open to fund management executives and industry service providers to the industry. CPAs, tax attorneys, compliance professions, administrators, custodians, consultants and prime brokers are welcome to take the study.

    The study’s purpose is to determine the level of industry preparedness and steps fund managers are taking to mitigate potential exposures to IRS Industry Focus Issue risk.  The goal of the survey is to help Sum2 better respond to the critical needs of fund managers and the alternative investment management industry by improving our just released IRS Audit Risk Program (IARP).

    This survey asks ten questions.  The questions concern your awareness of IFI and how it pertains to your fund or fund management practice. The survey seeks to determine overall industry risk awareness, potential exposure to IFI risk factors and any mitigation initiatives you plan to address IFI risk factors. It should take no more then 5 minutes to complete the questionnaire.

    Your participation in this study is completely voluntary. There are no foreseeable risks associated with this project. However, if you feel uncomfortable answering any questions, you can withdraw from the survey at any point. It is very important for us to learn your opinions.

    Your survey responses will be strictly confidential and data from this research will be reported only in the aggregate. Your information will be coded and will remain confidential.

    If you have questions at any time about the survey or the procedures, you may contact Sum2 at 973.287.7535 or e-mail us at customer.service@sum2.com

    Thank you for your participation.

    March 16, 2009 Posted by | IRS, risk management, Tax, taxation | , , , , , , , | Leave a comment

    Hedge Fund Audit Risk and Foreign Nationals

    irs-logo-no-text1Sum2 is conducting a study to determine fund management industry awareness and preparedness to address recent IRS initiatives concerning the use of Industry Focus Issues (IFI) to guide agency field engagements.

    The survey can be accessed here:

    IRS Audit Risk Survey for Hedge Funds

    Sum2 asked industry participants to take part in the survey that were not domiciled in the US. Though the IRS is not the national tax authority for fund managers located outside of the US the audit guidelines that the agency is developing has a high focus on foreign nationals investing in funds with a US nexus. This has implications for any individuals, institutions and subscribers to fund of funds regardless of their nationality. The IRS has developed three tiers of IFI that relate to the investment management industry and four (4 ) of the fourteen (14) First Tier IFI concerns foreign nationals participation in US domiciled partnerships. The IFI risk profiling that will guide agency field agents examination of investment partnerships and other fund structures will impact all partners in a investment fund corporation.

    The duration of the survey will be four weeks. Sum2 will be releasing interim weekly results of the survey. The first interim update will be released later today. So far respondents of the survey have indicated an extremely low level of awareness about the IFI and its potential impact on fund partnerships.

    One of the goals of the survey was to create visibility for our new IRS Audit Risk Program (IARP) product. In future releases of the product, we plan to incorporate other tax domiciles.

    We encourage all global participants to review the survey to determine how it may impact their fund management business.

    We also welcome any comments or insights from industry participants about how IFI may impact their investment fund partnerships company’s and how Sum2’s IARP can be improved to help investment partnerships more effectively mitigate and manage audit tax risk.

    In particular we welcome insights and intelligence on EU market application and best practices guidelines industry participants employ to monitor and manage tax audit threats. As with all risk management products, there is a lot of interest in the IARP product in the United States.

    We are looking forward to the release of subsequent additions of the IARP that speak to managing audit tax risk in other domiciles and tax jurisdictions.

    We welcome your insights into initiatives or trends that impact the global fund management industry.

    Thank you for your response.

    March 16, 2009 Posted by | hedge funds, IRS, off shore, private equity, regulatory, Tax | , , , , | Leave a comment