Tag Archives: hedge fund administrator

Hedge Fund Subscription & Withdrawal Process

The hedge fund subscription process (i.e. placing investor money into the fund’s brokerage account for investment) is a basic process that may be slightly different for each fund based on a number of factors.  Managers should make sure they understand the subscription process because investors may ask questions about the process and how the subscription amounts ultimately get into the fund’s trading account.  This post will discuss the framework for how subscription amounts move from the investor to the fund’s bank and brokerage accounts.

Bank Accounts

We previously discussed items related to establishing bank accounts for a hedge fund structure.  In general bank accounts will be established for the fund as well as the management company.  Establishing a bank account for a fund will be required when a fund’s broker requires all subscriptions and withdrawals to come from/go to a “same name” bank account.  Some managers may choose not to establish a bank account for the fund and simply have the prime broker deal with subscriptions, redemptions and fund expenses if their prime broker does not have “same name” requirements.  For the purposes of this article we generally discuss the subscription process with respect to structures where there are bank accounts for each individual fund.

Fund Administrator

The subscription process will be different if the fund utilizes a full service administrator instead of a non-full service administrator.

Full Service Fund Administration

If a fund’s administrator deals with the subscription process as well as the general accounting and NAV calculations (usually referred to as “full service” administration), then the fund manager generally will not deal with the subscription process at all.  Many times the “full service” administrator will actually establish (or work with the manager to establish) the bank and brokerage accounts and will dictate to the manager the subscription process.  Usually in these circumstances the administrator will also act as a “second signer” to add a layer of protection to the assets.  [Note: the “second signer” process essentially involves the fund administrator reviewing and approving all movements of money from the fund’s bank accounts.  While this service has been around for a number of years, it has become more common post-Madoff.]

Non- Full Service Fund Administration

For fund’s which do not have full service fund administration, the manager will be generally responsible for accepting subscription amounts and then making sure the amounts are properly moved to the brokerage account.  Generally the attorney will work with the manager to help the manager establish the proper structure and processes but managers should also discuss the process with the administrator to make sure all parties understand how the movement of subscription proceeds affect the calculation of the NAV.

Subscription Process in General

Generally the investor will wire the subscription amount to the fund’s bank account.  In the case of individual investors, subscriptions may sometimes be made by check.  Once the subscription amount has been credited to the fund’s bank account, it may either be wired to the fund’s brokerage account or it may sit there until the first

day of the trading period.*  Either the manager or the administrator (as described above) will work with the bank and broker to make sure the subscriptions are correctly transferred.

* Note: there are a number of different issues which may arise at this point including situations where the subscription is placed in the brokerage account before or after the first day of the trading period, and whether the investor will receive interest on the subscription amounts prior to the amounts being transferred to the brokerage account.  These issues should be discussed between the fund manager, administrator and lawyer prior to the fund launch.

Single Fund Structure – Domestic or Offshore Hedge Fund

In a single fund structure, whether the fund is located in the U.S. or offshore, moving subscription amounts is straight-forward.  Investors will place assets in the fund’s bank account and then the subscription amounts will be wired to the fund’s brokerage account. Generally a withdrawal is processed by a wire from the fund’s brokerage account to the fund’s bank account and then by a wire from the bank account to the withdrawing investor.  Depending on the broker, subscriptions and redemptions may be able to be effected directly between the investor and broker for credit/debit directly to the fund’s brokerage account.

Single Fund Subscription Process: Single Fund Structure Org Chart – Investor Subscription Process

Offshore Master-Feeder Hedge Funds

Offshore master-feeder funds will have process similar to the single entity fund structure process.  The general master-feeder hedge fund will have domestic taxable investors invest into a domestic feeder fund and offshore and non-taxable U.S. investors invest into an offshore feeder.  Both feeder funds will then invest directly into the master fund which ultimately makes investments directly.  A typical investment process might be: investors wire funds to the appropriate feeder fund bank account, the feeder fund then wires the subscription to the master fund bank account and from there the subscription amount would be wired to the brokerage account.  As above, withdrawals would be processed in the reverse order.

Master-Feeder Subscription Process: Master Feeder Org Chart – Investor Subscription Process

Mini-Master Hedge Funds

Mini-master hedge funds are becoming more popular because of cost considerations.  Additionally these structures can be easier to deal with from an operational perspective.  In the basic mini-master structure there will be two fund entities – an offshore fund and a domestic fund.  Then, like the traditional master-feeder structure, offshore investors and non-taxable U.S. investors will place their assets in the offshore feeder and U.S. taxable investors will place their assets in the domestic feeder.  Domestic investors will subscribe to the domestic fund which will act as the “master” fund.  From there the offshore fund will invest its assets in the domestic “master” fund, becoming in-essence an investor in the domestic fund. [Note: separate post on mini-master hedge funds to be coming soon.]

Mini-Master Fund Subscription Process: Mini-Master Org Chart – Investor Subscription Process

Other Items

The above discussion is general – each fund structure is unique and there may be certain reasons why a specific fund may have a process which is different from the discussion above.  Indeed, in many cases the administrator and broker may be able to handle subscription amounts which bypass the bank accounts or the feeder funds in master-feeder structures.  In any event, the fund manager’s operational team should work closely with the administrator to develop processes to ensure that the subscription process is seamless.  We have specifically not discussed offshore segregated portfolio companies or series LLC structures because these structures are unique and subscription processes may vary widely.


Cole-Frieman & Mallon LLP is a hedge fund law firm which provides comprehensive formation and SEC/CFTC regulatory support to start-up and established hedge fund managers.  Please contact us if you have any questions.

Bart Mallon, Esq. can be reached directly at 415-868-5345.  Karl Cole-Frieman can be reached at 415-352-2300.

Hedge Fund Audit Firms and Agreed Upon Procedures

Hedge Fund Due Diligence Firm Discusses “Agreed Upon Procedures”

We’ve published a number of thoughtful pieces on this blog from Chris Addy, president and CEO of Castle Hall Alternatives (see, for example, article on Hedge Fund Operational Issues and Failures).  Today we are publishing a piece by Chris which discusses hard to value hedge fund assets (so called Level III assets).  In certain situations hedge fund audit firms will be engaged to perform an “Agreed Upon Procedures” review of the pricing of these assets.  As discussed in the article below, agreed upon procedures engagements do not provide hedge fund investors with a great deal of comfort with regard to the pricing of these assets.  It is unclear whether in the future investors will push back with regard to such engagements and require more robust pricing audits.  The problem with more robust procedures, obviously, is increased cost (because of increased liability for the audit firms).

Managers who are engaging audit firms pursuant to agreed upon procedures should be aware that they may face tougher questions from investors going forward.


Agreed Upon Procedures

A number of our recent posts have focused on the challenges of the hedge fund administrator‘s role in relation to security valuation.  We will, of course, return to this topic – but, in the meantime, wanted to focus on some of the alternatives to administrator pricing.

One of the more common comments from today’s administrators is that, while an admin may be able to price Level I and Level II securities, they do not necessarily have information to price Level III instruments.  (To recap, the US accounting standard FAS 157 divides portfolios into three levels, being Level I, liquid instruments readily priced from a pricing feed (typically exchange traded); Level II, instruments priced using inputs from “comparable” securities (essentially mark to model, albeit with mainstream models); and Level III, everything else.)

This leaves investors with a challenge – if administrators cannot price Level III instruments, who can? Moreover, to repeat one of our frequent comments, it is self evident that if a hedge fund manager wishes to deliberately mismark securities, they would most likely misprice a Level III instrument.  It is, of course, very hard to fake the price of IBM common stock, but much easier to mismark emerging market private loans.

Two of the most common tools available to hedge fund managers looking for third party oversight over pricing for Level III instruments – assuming the administrator has washed their hands of the problem – are third party pricing agents and auditor agreed upon procedures, or “AUP”.  We will return to the strengths and weaknesses of third party pricing agents in a subsequent post, but wanted to focus this discussion on AUP.

In an Agreed Upon Procedures engagement, the auditor completes specific procedures which have been dictated by the client.  The procedures are specified and the auditor then prepares a report outlining the findings of that specific work.

We have two comments here: the first is to take a high level view as to the adequacy of these procedures, and the second is to dig a little more deeply into the actual audit guidance that covers this type of work.

Our first comment is, unfortunately, an Emporer Has No Clothes observation.  The significant majority of hedge fund AUP engagements we have seen require the auditor to test a fund’s pricing on a quarterly basis.  This usually involves (i) obtaining a portfolio list from the investment manager and (ii) testing the pricing support for those positions.

There are, however, generally two snags.  Firstly, many AUP only test a sample of prices, not the whole portfolio.  Sample testing clearly provides much less assurance than a price review of all positions: the administrator, for example, is usually expected to price the entire book (would any investor accept a NAV which has been priced on a “sample” basis???)

The bigger problem, however, is the type of testing completed by the auditor.  In way, way too many cases, the auditor tests security prices back to the manager’s own pricing support and makes no attempt to obtain independent pricing information.

This type of work is, clearly, somewhere between minimal and absolutely no value for investors.  If the auditor receives a spreadsheet from the manager showing the matrix of broker quotes received, how does the auditor know that the manager has not adjusted that spreadsheet to exclude quotes which were uncomfortably low?  Even more importantly, if all the auditor does is to check prices back to pieces of paper in the manager’s own pricing file, how does the auditor know that those pieces of paper are genuine?  As we have said before, and will keep on saying, it only costs $500 to buy a copy of Adobe Photoshop if you are of a mind to alter documentation.

When discussing this type of work, the manager typically notes that, if the auditor was to complete a full, independent pricing review, it would be too costly and too time consuming to be practical on a quarterly basis.  A full, GAAP audit review is, of course, performed at year end – this does include independent pricing (although – investor fyi – auditors will still only sample test many portfolios.)

While these are fair points, it remains the case that this type of AUP provides minimal protection against pricing fraud.  In the meantime, the manager gets the marketing benefit of being able to claim enhanced scrutiny and oversight from a Big 4 firm each quarter.

Which leads to our second point.  Why would an auditor accept to complete agreed upon procedures when any reasonable accountant would rapidly conclude that the typical scope of these AUP provide pretty much nil controls assurance?  Why does the auditor not insist that, if their name is to be associated to this work, then the procedures must be meaningful and sufficient to meet an actual control standard?

To this point, the actual audit standard applicable to AUP is available here.  The standard states:

An agreed-upon procedures engagement is one in which a practitioner is engaged by a client to issue a report of findings based on specific procedures performed on subject matter. The client engages the practitioner to assist specified parties in evaluating subject matter or an assertion as a result of a need or needs of the specified parties. Because the specified parties require that findings be independently derived, the services of a practitioner are obtained to perform procedures and report his or her findings. The specified parties and the practitioner agree upon the procedures to be performed by the practitioner that the specified parties believe are appropriate. Because the needs of the specified parties may vary widely, the nature, timing, and extent of the agreed upon procedures may vary as well; consequently, the specified parties assume responsibility for the sufficiency of the procedures since they best understand their own needs. In an engagement performed under this section, the practitioner does not perform an examination or a review, as discussed in section 101, and does not provide an opinion or negative assurance. Instead, the practitioner’s report on agreed-upon procedures should be in the form of procedures and findings.

In practice, this all gets horribly circular.  Per the standard, a client requests an auditor to complete AUP to assist “specified parties” to “evaluate subject matter or an assertion”.  In our case, the assertion would be “are hard to value securities valued correctly at quarter end.”

However, the specified party is usually the manager itself, making the client and specified party the same person.  The particular trick applied, in many cases, is for the auditor to seek to prevent the investor from actually seeing the AUP in the first place!  However, if the investor is to have access to the AUP, the auditor universally requires the investor to sign a Catch 22 document which requires the investor to acknowledge that the AUP are “sufficient for their needs”.  So, even if the investor believes that the AUP are not “sufficient for their needs” – which is hardly a long stretch – the investor has to sign that the procedures are sufficient if they are to even see the auditor’s work.  With this magic piece of paper, the auditor has met its requirements and can sleep easy.  Meanwhile, the auditor will send a bill to – guess who – the fund, meaning that investors have, once more, had to foot the bill.

As always, Caveat Emptor.


Hedge Fund Operational Due Diligence


Related hedge fund law articles:

Bart Mallon, Esq. of Cole-Frieman & Mallon LLP runs Hedge Fund Law Blog and can be reached directly at 415-868-5345.

Bay Area Hedge Fund Roundtable Event

Panel Discussion on State of Hedge Fund Industry

Yesterday afternoon (May 6th) the Bay Area Hedge Fund Roundtable, a group of professionals within the hedge fund industry, gathered for a panel presentation entitled “Change…Critical Legal, Tax, Acounting and Regulatory Updates You Need to Know.”  The presentation was moderated by Pamela S. Nichter (Osterweis Capital Management) and included the following panel participants:

Vincent J. Calcagno (Rothstein Kass)
Geoffrey Haynes (Shartsis Friese)
Tony Hassan (Ernst & Young)
Anita K. Krug (Howard Rice)

Presentations like these are great because they allow professionals to share insights into what is going on in different parts of the industry – many of the topics discussed allowed the panelists to really dig deep into the issues and provide some context to what is happening at both the regulatory and investor levels.  I took notes during the presentation and will summarize some of the main points discussed by each of the presenters (please don’t hold anything against the speakers if I mis-paraphrase or mis-interpret and as always nothing in this summary is tax or legal advice)…

Anita K. Krug

Anita discussed a number of the laws which have been discussed or proposed over the past 6 to 8 months including the following:

  • Barney Frank’s Recent Comments (see Reuters article)
  • Mary Shapiro’s Recent Comments (see Bloomberg article where Shapiro says she wants the ability to make rules regulating hedge funds)
  • Discussion of the Hedge Fund Transparency Act which was proposed in the Senate earlier this year (see also Overview of the Hedge Fund Transparency Act)
  • Hedge Fund Advisor Registration Act which was proposed in the House earlier this year
  • Geithner’s hedge fund proposals (see NY Times article for background information)
  • Discussion of the past short selling rules (see HFLB article) and the new short selling rules which will be closer to the old “uptick” rule (see SEC overview; note: I have not yet had an opportunity to thoroughly review these proposed rules)
  • European Rules which have been proposed which may have an effect on US based managers with EU investors (Anita raised many of the same issues which were also raised in this article)

Geoffrey Haynes and Vincent J. Calcagno

Geoffrey and Vincent went back and forth discussing some of the tax issues which managers are likely to face this year and potentially going forward.  This discussion included the following issues:

  • Discussion of the new offshore deferral rules by dint of new Section 457A of the Internal Revenue Code (see generally this alert).  Note: discussions on the ramifications of this new section to managers who currently have deferral arrangements took a majority of the time.  There are a number of issues involved including issues with side pockets, options, and non-conventional performance fee periods.
  • San Francisco Payroll Tax of 1.5% (see background on this issue here)
  • Discussion of the Levin proposal to tax the carried interest as ordinary income (see Hedge Fund Carried Tax Increase?).  [The panelists seemed to think that Congress would not vote on this bill until sometime in 2010 (if the bill was actually even voted on) with an effective date, if passed, of sometime in 2010 – the panelists did not seem to think it would be retroactively applied.]
  • Discussion of a bill which would eliminate UBTI for U.S. based non-taxable investors investing in U.S. hedge funds which utilize leverage (note: I was not aware of this bill and am not sure what bill exactly was referred to – please feel free to contact me if you know about this bill).  The panelists seemed to think this bill was likely DOA.
  • Discussion of the Stop Tax Haven Abuse Bill by Senator Levin (see Senator Levin’s press release)
  • Discussion of Obama’s Offshore Tax Plan (see generally the White House press release)

Tony Hassan

Tony discusses what is changing in the area of hedge fund operations.  Tony’s discussion of current topics was maybe one of the more important parts of the panel in terms of providing insight on current investing trends and due diligence requests.  Many of the items in this section were part of a dialogue between Tony and Vince as noted in the parenthesis below.

  • There is no secret that due diligence is a more central and important part of the investing process than it was previously.  (Tony and Vince)
  • Due diligence is also changing in many respects – at E&Y Tony has had specific requests from potential invests to send them directly the financial statements.  Of course this brings up many legal and client issues (the hedge fund, not the potential investor, is the client of E&Y) and because of this these requests are often denied. (Vince)
  • Managers are providing verified transparency “quarterly reviews” which aim to show investors that the fund’s assets are actually there.  (Vince)
  • Some funds are instituting a half-yearly audit (in addition to the end of year audit).  (Vince)
  • Some funds are instituting agreed upon procedure reports.  In these reports the auditor will come in an verify that certain procedures are being completed.  This may be especially important with regard to the valuation of the fund’s assets.  (Vince)
  • Tony noted that this is really a new form of due diligence and used the term “Hedge Fund Due Diligence 2.0” – a term I used in October of 2008 (see post).
  • Investor questions to hedge funds are changing.  While previous questions would have stopped after “Do you have a 3rd party administrator?”  Now the questioning continues – investors want to know about the administrators technical expertise, who exactly will be the account representative and what type of capital markets experience does that person or group have, what inputs will be used to value assets, etc.  Investors also want to know what sort of contingency plan is in place should the administrator fail or if there is a disaster; investors will want to know if the fund is keeping shadow books.  (Tony)
  • Tony also participated in the discussion with Pamela below with regard to managed accounts.

Pamela S. Nichter

Pamela, the moderator of the discussion, also weighted in on certain operational issues which fund managers should be prepared for in the new climate.  In general Ms. Nichter is seeing more investor requests and communications.  Now there is greater communication between the investor and the fund manager.  Ms. Nichter also discussed the trend toward greater liquidity and transparency through separate account structures.

Separate accounts are something that more and more investors are seeking but there are many considerations for managers.  Specifically separate accounts can be a drain on resources, especially if the investors request their own specific administrators or auditors.  Because of the greater amount of resources which need to go into the back office to handle what is in essence a more traditional asset management business, the manager must be ready to change the business model to a certain extent.  Specific issues will include:

  • having a robust trade allocation policy
  • understanding that there is likely to be a disparity of performance
  • potential registration issues
  • potential integration issues
  • performance reporting issues (may need to go back to GIPS)

Questions and Conclusion

After the panel finished their discussion the floor was open to questions.  During this time there were a number of good questions.  One issue focused on what will performance fees look like going forward which led to a discussion about creative performance fees (like instituting some sort of clawback provision like what is found in private equity funds).  Another issue was whether and to what extent the Managed Funds Association will be representing the industry during this time of legislative/regulatory changes.  The answer is that the MFA will be doing everything it possibly can to represent the hedge fund industry and it is our job to make sure that the MFA knows how the industry feels about many of the current legislative proposals.

Hedge Fund Administrator Charity

As described in the press release reprinted below a hedge fund administrator is providing reduced fees to clients who donate their set up fees to Hedge Funds Care, a charity which benefits abused children.  Hedge Funds Care puts on a number of events throughout the US.  The San Francisco Hedge Funds Care group will be putting on an event on March 11 – more on this event to be forthcoming.


Hedge Fund Administrator Offers Discount Pricing to Emerging Hedge Fund Managers Who Donate Set-up Fees to Hedge Funds Care

NEW YORK, Feb. 17 /PRNewswire/ — Variman LLC, (www.variman.com) a boutique provider of hedge fund administration, middle and back office services, joins together with Hedge Funds Care (www.hedgefundscare.org) to increase awareness of child abuse and assist its efforts to prevent and treat child abuse.

Variman Fund Services will offer discounted monthly service fees to emerging managers who donate the standard set-up fee to Hedge Funds Care on behalf of Variman LLC for a limited time.
Given the difficult times our industry is currently facing, Variman Fund Services, in an effort to support both the needs of the marketplace and those of abused children, believes this initiative will be worthwhile and bring solid value to all involved.

For further information, please log on to www.variman.com and provide contact information as needed for a quick response. This is a limited time offer and applies to emerging hedge fund managers requiring hedge fund administration. All information will be held strictly confidential.

About Variman LLC

Variman LLC, headquartered in Short Hills, NJ, USA with offices in Dubai and India, brings a fresh perspective to Capital Markets Operations and Hedge Fund Administration with its unique service platform to provide complete visibility to all aspects of post-trade processing including liquidity management and collateral optimization

Variman Fund Services remains one of the few administrators to offer bespoke white glove services according to client requirements and budget. Variman Fund Services can efficiently deal with multiple brokers, global middle and back office operations and accounting functions across asset all classes and time zones.

About Hedge Funds Care

Founder Rob Davis established Hedge Funds Care in 1998 with the dream of helping to prevent and treat child abuse. With the encouragement and participation of his colleagues in the hedge fund industry, the first Open Your Heart to the Children Benefit took place in New York in February of 1999 and raised $542,000. What began as a single fundraiser has grown into an international nonprofit organization. Hedge Funds Care has distributed over $18 million through more than 500 grants. In 2009, annual benefits will take place in New York, San Francisco, Chicago, Atlanta, Boston, Denver, Toronto, London and the Cayman Islands. Through the ongoing generosity and commitment of hedge fund industry professionals, HFC continues its rapid expansion. We anticipate future growth to cities in the U.S. and abroad.

Hedge Fund Law Questions

Recently I have received a few good hedge fund law questions.  Please remember that these answers are general discussions of the law and should not be a substitute for actual legal advice.  This discussion does not form an attorney-client relationship, please see our disclaimer.


Question: [with reference to the new Hedge Fund Registration article] So what’s to say a hedge fund can’t just become the outside advisor to a series of managed accounts?  If so, does the fund still need to register?

Answer:  Many hedge fund management companies do provide individual account management outside of the hedge fund.  Typically this is described as hedge fund separately managed accounts. There are many reasons why a manager may have such accounts, including the fact that many large institutional investors require that their assets be managed in this way.

With regard to registration, yes a manager may have to register as an investment advisor if he manages separately managed accounts outside of the hedge fund.  There are two separate levels of registration – State and SEC.  Generally the SEC does not require a manager to register unless the manager has 14 or less clients over the last 12 months.  This generally means that a hedge fund manager can have 13 separately managed account clients (in addition to the hedge fund) without implicating the SEC registration requirements (see Hedge Fund Registration Exemption).  However, states are free to adopt their own registration laws and many would require a manager with 5 separately managed account clients (in addition to the hedge fund) to register as an investment advisor with the state securities commission.

Each manager’s situation is unique and if the manager has specific questions regarding his legal or registration status he should discuss with legal counsel.  Additionally, if the Hedge Fund Transparency Act is passed, it is likely that hedge fund managers with $50 million or more of AUM will need to register as investment advisors with the SEC.

Question:  Regarding the 3c7 Funds, does the counting of investors require a ‘look through’?  I.e. If an qualified investor was a Fund of Funds, would the counting up to the limit of 500 investors require counting the underlying investor of the Fund of Funds?

Answer: If the investing fund was also a Section 3(c)(7) hedge fund then there would be no “look through.”  If the investing fund was a Section 3(c)(1) hedge fund then there would be certain issues which the Section 3(c)(1) would need to take into consideration.  We will be writing a post about this issue shortly.

Question: What happens if you are NOT an accredited investor, but you have already been allowed to invest into a hedge fund that requires you to be an accredited investor?

Answer: I am not quite sure how this would happen but I believe there might be two separate ways.  First, the investor may have lied in the hedge fund subscription documents.  The subscription documents require the investor to make certain representations regarding the investor’s net worth.  Generally hedge fund managers have no duty to inquire further about the representations made in the subscription documents.  If this happens then generally the investor will not receive the protections under the law for non-accredited investors.

Second, the investor may have been an accredited investor at the time the subscription documents were signed and, because of outside circumstances, the investor later becomes a non-accredited investor.  In this instance the newly non-accredited investor should immediately contact the hedge fund manager and inform him of the new circumstances.

Question: Can you recommend a cost-effective (cheap) administrator for a hedge fund start up?

Answer: Yes.  It is common for me to provide clients with recommendations for all service providers including hedge fund administrators.  There are many hedge fund administration firms and there are many low cost providers which I can put you in touch with.  Usually I will want to get to know you and your firm before I make recommendations.  If you are interested, please contact us now.

Hedge Fund Audits Post Madoff

Hedge Fund Audits Expected to Increase in Importance

The Madoff scandal has shown the hedge fund industry many things, not the least of which is the importance of hedge fund audits.  While the details of Madoff’s audits are still a little unclear, it has been widely reported that the audit firm he used was a little known shop which is tightlipped.  This article investigates reaction of hedge fund investors with regard to hedge fund audits going forward.  (Please note, the Maddoff investment firm was not a hedge fund; however, the scandal will likely have a great influence on hedge fund due diligence and audit standards.) Continue reading

SEC Stands Behind “Fair Value” Accounting

FASB may re-evaluate FAS 157 in light of recent market events

While the SEC does not directly control the manner in which hedge fund assets are valued for the purpose of striking a NAV for a fund, the SEC valuation policies are important for hedge funds in a number of different ways.  Maybe most important is that the SEC valuation guidelines require issuers of securities to adhere to certain valuation practices with regard to their own assets.  Recently Congress mandated the SEC reevaluate its valuation guidelines in light of the market collapse of 2008. Continue reading

Operational Issues for Hedge Fund Managers Using Multiple Prime Brokers

The hedge fund and investment management industry has seen many radical changes during the last year, including the consolidation (or elimination) of the large prime brokerage firms.  Because of these events many funds have moved to a multi-prime broker model instead of the more traditional single prime broker model.  There are obviously many advantages to going to a multi-prime broker model (including the reduction of prime broker bankruptcy risks), but there are also many logistical issues which need to be considered.

Start up hedge funds which wish to use a multi-prime broker approach should discuss this option with their hedge fund attorney as well as their hedge fund administrator which will be able to help with the back end aggregation of the prime brokerage fees.  Additionally, managers may want to seek a software solution like the one from Advent described in the press release below.  Continue reading

Hedge Fund Administrator Completes SAS 70 Type II (Press Release)

GlobeOp Successfully Completes SAS 70 Type II Examination for Second Consecutive Year

LONDON, UK; NEW YORK, NY, USA – 4 December 2008 – GlobeOp Financial Services (“GlobeOp®”, LSE:GO.) today announced that, for the second consecutive year, it has successfully completed a SAS 70 Type II examination of specified middle-, back-office and fund administration controls by accounting and auditing firm Ernst & Young LLP. Continue reading

Hedge Fund Administration – New Issues for Managers to Consider

I came across another very good article which examines the new landscape of the hedge fund industry and brings up some pertinent points which both hedge fund managers and investors should be aware of.  The issue is that many of the prime brokerage firms and very large global banks have established administration businesses to cater to the ever growing hedge fund industry.  While this expansion gives managers more choices for administration (and arguably better service as admin and other back office functions, like banking, can be handled by one organization), it does create new risks that both managers and investors should investigate.  This article details some of the issues which should be considered; these issues should probably be talking points between the manager and the administrator during the process of choosing an administrator.   The original article can be found here: www.castlehallalternatives.com.

How will the credit crisis impact the administration industry?

In the past two weeks, Fortis has been rescued not once, but twice.  While hardly at the top of the priority list in times of global economic meltdown, it’s still an interesting question to ask what would have happened to Fortis’ administration business if the bank had ceased operations.

Thinking of a different point, it’s also ironic – and fortuitous – that Lehman was one of the few of the prime brokers which had not decided to create a fund admin sideline to help attract managers to the firm’s PB services.

In this environment, however, both hedge fund managers and investors need to evaluate the stability and viability of fund administration entities.  There is both a possibility of direct bankruptcy and also a risk that a parent entity in financial distress could decide to close a peripheral admin business in short order.
We can immediately think of several issues:

1) If the administrator goes bankrupt, do funds have a contingency plan in place to enable them to continue operations?  Do hedge funds have copies (ideally electronic) of the administrator’s accounting which could be given to a new provider?

While audit firms in the US may not agree with us (they tend to audit the manager’s accounting and largely ignore the admin), the offshore administrator’s accounting forms the official books and records of a hedge fund.  If the administrator is no longer in business, does the fund have a contingency plan to recover those records so that the next NAV can be struck on a timely basis?

2) Administrators usually control cash movements for subscriptions, redemptions and fund expense payments.

Do these cash movements pass through a cash account within the administrator?  This would, of course, expose a fund to loss if cash is sitting in an account at the time of bankruptcy.

More discreetly, does the administrator use some form of commingled Escrow account to receive incoming subscriptions and perhaps hold cash until anti money laundering procedures have been completed?  Are hedge funds sure that these assets are properly segregated and controlled?

Separately, if the administrator is the only one with signing authority over the offshore bank account, can the manager withdraw any residual cash and process new redemption and expense payments if the signatories are no longer available?

3) If administrators complete anti money laundering and know your customer checks, does the hedge fund have access to these records to prove that AML has been performed in the event that the admin is bankrupt?

4) Does the hedge fund have access to the full shareholder’s register / list of partners capital accounts to identify all investor balances in the event that the administrator is bankrupt?

More generally, it’s worth noting that many administration companies are small, independent firms which may not be well capitalized.  In an environment which sees a sharp fall in hedge fund assets through both negative performance and net redemptions, administrators’ fees will also fall. Administrator financial viability is, therefore, a real issue for both managers and investors as we navigate the coming year.

HFLB note – other related articles include: