Mar 2014 About Lenox Park: Lenox Park is an independent Due Diligence Advisory firm with offices in Westchester, New York and Austin, Texas. The firm’s clients include a broad network of Investors including Pension Funds, Family Offices, Endowments, Foundations and Financial Institutions. Lenox Park was established in 2009 to address a growing need in the Investment Management industry for independent, conflict-free Advisory work. The firm has been retained by some of the largest institutions in the U.S. to assist in evaluating Investment Managers & Strategies, Emerging Manager Internal Audit and Derivatives & Regulatory Exposures. The firm also provides technology solutions to its institutional client base through it subsidiary, Lenox Park Solutions LLC. Lenox Park +1 (888) 819-2330 [email protected]www.lenoxparkllc.com Key Concepts for Manager Due Diligence: Alternative Investments 1 Executive Summary The financial crisis of 2008 sharply illuminated the growing importance and substantial allocations made to Alternative Investments among Institutional Investors. According to a report published by McKinsey & Company 2 , in the 5 years since the crisis, Alternative Investments grew 7 times faster than traditional investments. Unfortunately, many Investors have experienced losses or underperformance in this segment of the investment management industry under the weight of some type of Investment Manager dysfunction: malfeasance, poor or nonexistent risk management, inadequate operations or controls, unhealthy cultures, etc. Investors that have been unscathed most likely take comfort in the fact that they or their “Advisors” (for this paper, meaning Investment Consultants, FundofFunds or Due Diligence Advisory firms) performed more robust and comprehensive due diligence on their select investments and the Investment Managers behind them. It’s true that some aspects of the due diligence process have become easier due to technological advances and the availability of data. This has led some firms to become data aggregators. But the elements of due diligence that have always been difficult to grasp are still difficult; and they remain largely unchecked. In this paper, we will provide support for our belief that more attention should be paid to the Operations & Oversight functions governing organizational controls, policies and procedures; and the qualitative aspects of the Manager Background its people, its culture and ownership structure. We will also affirm that this work is only done effectively when performed by experienced professionals who will conduct the work independently and free of conflicts. Table of Contents: A Constructive Approach to Due Diligence (pg 2) SEC Risk Alert: Due Diligence for Alternative Investments (pg 2) Why the Qualitative Elements Matter (pg 5) Lenox Park Due Diligence Dashboard (pg 6) Case Study: The Galleon Group Closed Down due to Insider Trading (pg 7) Lenox Park Experience & Firm Overview (pg 8) Endnotes (pg 8)
Transcript
Mar 2014
About Lenox Park: Lenox Park is an independent Due Diligence Advisory firm with offices in Westchester, New York and Austin, Texas. The firm’s clients include a broad network of Investors including Pension Funds, Family Offices, Endowments, Foundations and Financial Institutions. Lenox Park was established in 2009 to address a growing need in the Investment Management industry for independent, conflict-free Advisory work. The firm has been retained by some of the largest institutions in the U.S. to assist in evaluating Investment Managers & Strategies, Emerging Manager Internal Audit and Derivatives & Regulatory Exposures. The firm also provides technology solutions to its institutional client base through it subsidiary, Lenox Park Solutions LLC.
Executive Summary The financial crisis of 2008 sharply illuminated the growing importance and substantial allocations made to Alternative Investments among Institutional Investors. According to a report published by McKinsey & Company2, in the 5 years since the crisis, Alternative Investments grew 7 times faster than traditional investments. Unfortunately, many Investors have experienced losses or underperformance in this segment of the investment management industry under the weight of some type of Investment Manager dysfunction: malfeasance, poor or non-‐existent risk management, inadequate operations or controls, unhealthy cultures, etc. Investors that have been unscathed most likely take comfort in the fact that they or their “Advisors” (for this paper, meaning Investment Consultants, Fund-‐of-‐Funds or Due Diligence Advisory firms) performed more robust and comprehensive due diligence on their select investments and the Investment Managers behind them. It’s true that some aspects of the due diligence process have become easier due to technological advances and the availability of data. This has led some firms to become data aggregators. But the elements of due diligence that have always been difficult to grasp are still difficult; and they remain largely unchecked. In this paper, we will provide support for our belief that more attention should be paid to the Operations & Oversight functions governing organizational controls, policies and procedures; and the qualitative aspects of the Manager Background - its people, its culture and ownership structure. We will also affirm that this work is only done effectively when performed by experienced professionals who will conduct the work independently and free of conflicts.
Table of Contents: A Constructive Approach
to Due Diligence (pg 2)
SEC Risk Alert: Due Diligence for Alternative
Investments (pg 2)
Why the Qualitative Elements Matter (pg 5)
Lenox Park Due Diligence Dashboard (pg 6)
Case Study: The Galleon Group Closed Down due to
Insider Trading (pg 7)
Lenox Park Experience & Firm Overview (pg 8)
Endnotes (pg 8)
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A Constructive Approach to Due Diligence When Alternative Investments were only accessible to a small, select group of Investors, the due diligence required to analyze them consisted primarily of interviewing Managers about strategy and examining track records and past performance. The explosive growth in this segment over the years has corresponded to increased accessibility and availability of data and metrics for potential Investors. Consequently, due diligence evolved to reflect this new reality and many Advisors now rely too heavily on an ability to aggregate vast amounts of data in order to examine the health and potential of an investment and its Manager. In our view, this approach unfortunately overlooks the importance of the qualitative elements of due diligence, which too often seem to be put on the back burner. Some of the largest Investors in the Alternatives space, including Pension Funds, Foundations and Endowments, appear to be shifting away from Fund-‐of-‐Funds and increasing direct exposure to Managers3. As they do, we hope a more comprehensive approach to due diligence will be employed. Budget constraints sometimes prevent these organizations from assembling all the necessary resources internally in order to conduct comprehensive due diligence. In such cases, substantial portions, if not all of the work may be outsourced. We believe that much of the risks and rewards of investing in Alternatives can be determined by using a multifaceted approach that includes both a robust qualitative analysis of Managers, staff and the culture of their organization and a strong quantitative assessment of the fund’s data.
Managing Conflicts Investment Consultants, Fund-‐of-‐Funds or Due Diligence Advisory firms (referred to in this paper as “Advisors”) may become conflicted when charged with performing due diligence. This is particularly true if, in addition to conducting due diligence, their parent companies or affiliated companies are promoting proprietary fund management businesses. In some cases, Advisors are affiliated with investment banks or broker/dealers. These potential conflicts certainly do not imply any impropriety, but they have not gone unnoticed by Investors and regulators, and they do need to be investigated before any engagement. In fact, the SEC recently alerted Investors to these concerns (see “Regulatory Outlook”). We believe the first step to a robust due diligence process is an assurance that an independent, conflict-‐free Advisor will conduct the work.
Experienced Professionals to Conduct Due Diligence The engagement of seasoned professionals from the beginning to the end of a due diligence assignment has several distinct advantages. First, experienced professionals are usually better equipped to question a Manager’s assumptions, ask detailed follow-‐up questions and explore every possible line of inquiry. Sniffing out inconsistencies or subtle problems comes more naturally to experienced professionals. Second, the process of due diligence requires a certain amount of diplomatic skill that most junior staff lack. Seasoned professionals conducting due diligence can more effectively interview the founders, board members or decision-‐makers at a Manager, many of whom are highly accomplished individuals. In some cases, managing sizable egos can present challenges to the work. Ideally, the relationship between Investors and the Manager will be a positive, long-‐running partnership. An experienced professional conducting due diligence can convey this ideal in a way that results in a process where the Manager is open and forthcoming with information.
Accommodate Nuances to Each Manager & Strategy Because each investment opportunity is unique, the due diligence employed to examine it should be customized to some extent. While many aspects of the due diligence process will remain consistent, each mandate should have some tailoring to reflect its unique situation. A large, established hedge fund with a long track record would likely require a different approach than a new Manager who may have just launched their first fund.
Conducting comprehensive due diligence often feels like investigative journalism: we know there is a story behind every Manager, and we want to examine it from all angles and pursue every lead. Sometimes the legal documents or data provided by the fund may spark a storyline; in other cases we may discover that an organizational structure is lacking in accountability or proper controls. In both cases, we should aggressively search for explanations.
Regulatory Outlook: SEC Office of Compliance Inspections & Examinations (“OCIE”) Risk Alert - Due Diligence Policies & Procedures The proliferation of Alternative Investments, in concert with the problems revealed by the 2008 financial crisis, has resulted in regulators keeping a more watchful eye on due diligence practices.
As recently as January 28th 2014, the Securities Exchange Commission (“SEC”) through the OCIE signaled that it may tighten regulatory expectations that govern the due diligence responsibilities of Investment Advisors that allocate to or recommend Investment Managers.
The SEC notes that Investment Advisors are fiduciaries and are required to act in their clients’ best interests and identify any conflicts of interest they may have when recommending investments. Our interpretation is that this risk alert is targeted at Fund-of-Funds and Pension Investment Consultants.
By examining more than 10 Investment Advisors, the SEC revealed some concern about deficiencies in due diligence practices as they relate to compliance with the Investment Advisors Act. Material concerns in their findings include:
False marketing claims
Failure to include due diligence policies and procedures in annual reviews
Failure to fully disclose practices to clients, and
Conflicts of interest that contaminate an Investment Advisor’s due diligence process
The SEC suggests that firms that recommend or allocate to Investment Advisors on behalf of clients adopt firm due diligence policies and procedures and then communicate them clearly and regularly to their clients.
*Source: www.sec.gov
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Rigorous & Disciplined Framework Examining the potential and health of an Alternative Investment opportunity requires assembling copious amounts of data, interview notes, financial statements and the like. In order to conduct a thorough analysis and make sense of the information gathered, we must proceed with a sound, specific framework. At Lenox Park, there are 6 elements to an effective due diligence framework: Manager Background, Strategy & Performance, Fund Structure & Legal Review, Operations & Oversight, Information Technology and References.
Figure 1: Lenox Park Proprietary Due Diligence Framework.
The early stages of analysis require substantial gathering of information and documents. A considerable amount of this data is obtained by asking the Manager to complete and submit a Due Diligence Questionnaire (“DDQ”). While every stone must be turned and verified, there is much that can be done before engaging the Manager. Advisors should consider limiting requests to information that is not publicly available or easily accessible. While all information must be verified, a significant amount of information can be gathered from websites, public filings, etc. All parties benefit and substantial goodwill can be built when an Advisor is respectful of a Manager’s time. After all, Managers should be managing portfolios. Putting in the hard work up front to gather, review and analyze the information is an imperative part of the process. At Lenox Park, we’ve found that by digging deeply into the materials before moving to the onsite interviews, we are prepared to ask the most meaningful questions and well-‐positioned to challenge Managers and push for greater clarity.
Manager Background A Manager’s experience and background must be carefully investigated. While much of this information can be gleaned from marketing materials and publicly available information, verifying through interviews and onsite visits is imperative.
Culture: We cannot emphasize enough how important it is to understand the culture of an organization. Understanding how individuals are motivated and what it feels like to work at an organization is crucial in attempting to predict behavior in certain scenarios. Organizations that encourage a high-‐pressure workplace often experience greater levels of risk-‐taking and much lower levels of compliance to firm policies or industry regulations.
Compensation: Managers may be reluctant to provide compensation details during due diligence, but it is a valuable part of the overall story. It reveals a tremendous amount about how key persons are motivated – which in our experience has high predictive value for behavior in various scenarios. We believe that successful Managers share successes, incentives and ownership fairly among staff. Material imbalances in compensation often result in dissatisfied, unstable staff and ultimately higher turnover.
Staff: For an established Manager, it is crucial to have a deep bench from which to draw talent, in the event that one or more of the key persons is no longer at the organization. While one can draw conclusions from an organizational chart and easily determine how many people work at a firm and who they report to, there is no substitute for personal interviews with key staff and face-‐to-‐face meetings. By spending time onsite, we can determine if teams are healthy and functional. It is important for Advisors to conduct background checks, identify Politically Exposed Persons and verify any history of the team working together at previous organizations.
Regulatory History: If a Manager or any staff, particularly key persons, have had official interactions with a regulatory agency like the SEC or Financial Industry Regulatory Authority (“FINRA”), the circumstances surrounding that interaction must be thoroughly investigated. There are cases where such interaction with a regulatory agency may be plausible, or explainable, in which case it should not result in the immediate disqualification of a Manager. A significant amount can be learned from the manner in which a regulatory subpoena or inquiry was handled by the Manager – responsiveness, documentation, etc.
Charitable & Political Contributions: Increasingly, our due diligence on a Manager includes a review of their public contracts, political contributions and lobbying activities. Investors need as clear an understanding of any potential conflicts and
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political activity that may be illegal or distracting. Deep political connections and ties to industry groups or household political figures may have once been an advantage for Managers. Today, that may not be the case.
Operations and Oversight In our experience, an overwhelming proportion of the uncertainty of investing in Alternative Investments falls within Operations & Oversight. For the average Lenox Park mandate, approximately 40 to 45% of the time spent on the entire due diligence mandate ends up within the area of Operations & Oversight. Many of the major fraud cases over the past decade would have been detected with a better understanding of the Managers’ operations and oversight functions. The Stanford Group used an accountant that never returned phone calls; the Bayou Group fired their auditor and took over that function in-‐house; Westgate Capital Management created a fictitious accounting firm and provided investors bogus audited financial statements. And of course, Bernie Madoff left a trail of evidence suggesting weak operations and limited compliance.
Managers who are small or new, sometimes referred to as Emerging Managers, are particularly prone to under-‐developed operations or systems of internal controls. In many cases, an Investor is comfortable with Managers at this stage in their organizational lifecycle and the due diligence conducted will take this into account. A corporate governance handbook or manual with clear, concrete policies and tangible procedures signifies institutional-‐level seriousness about the firm’s operations. While combing through the details of a firm’s operations, and engaging in staff interviews, the Manager’s method of identifying and controlling operational risk should become evident. If applicable, valuation methodologies and separation of duties should be reviewed. In all cases, the Manager should be able to demonstrate clear standards for monitoring, reporting and communication with Investors.
Strategy & Performance It is imperative that we understand a Manager’s strategy and verify track records. Thorough due diligence requires going well beyond the marketing materials to examine the strategy independently. This is almost always an iterative process, requiring multiple discussions with the Portfolio Manager(s) directly in order to reconcile the stated strategy of the Manager and the composition of portfolios.
A silver lining of the financial crisis has been the substantial improvement in the quality and accessibility of data analytics around performance. In our experience, and in most industry surveys, establishing a proven performance track record remains the most important determining factor in Investors allocating to a Manager. Today, a combination of standardized practices, analytic packages and 3rd party specialists make it much easier to gather comfort around performance metrics and benchmarking. As a result, more resources can be allocated to the elements of due diligence that take more time and require more qualitative analysis rather than quantitative. Fund Structure & Legal Review Terms and fee structures that have traditionally accompanied Alternative Investments found themselves under scrutiny post 2008, particularly for Hedge Funds and Fund-‐of-‐Funds. Consequently, some Investors have seized opportunities to negotiate fees and liquidity terms. These negotiations coupled with a Manager’s appetite for raising capital may lead to unequal fees among Investors and improper incentives for Managers. There is ample cause for a deeper review if such arrangements are not fully disclosed by the Manager. Hedge Funds, in particular, learned during the financial crisis the importance of adopting clear terms that govern procedures for Investors to redeem their investment capital. Comprehensive due diligence should confirm that a Manager has policies in place that clearly outline their procedures for providing liquidity to Investors. Additionally, a thorough review of a Manager’s history of providing or denying liquidity to Investors can shed light on how a Manager might behave in certain scenarios. In reviewing a Manager’s stable of service providers, both at the General Partner level and at the Fund level, there are various exposures to consider. Reputable and market-‐leading firms are almost always a better starting point during due diligence, but the work should still be done. There should be no assumption that lesser-known firms are incapable of providing adequate services; or that larger, better-known firms carry no risks. Managers that were exposed to Lehman Brothers’ Prime Brokerage unit when the firm filed for Chapter 11 protection, were left scrambling to claim assets, line up financing and other Prime services. Not long afterwards, the sensational meltdown and
Due Diligence War Stories (1 of 2) Manager Background Concerns were raised when we discovered that a Key Person, responsible for all Manager selection at a Fund-of-Funds, was significantly underrepresented in the equity ownership of the firm.
- Several interviews with the individual and the founders of the firm signaled warnings that this issue may have been a repeated source of frustration for the individual
- It also appeared the founders had a history that demonstrated they were not as generous with the profits of the firm or equity participation
- This raised concerns about a pattern of unacceptably high turnover for senior staff members
- 9 months after we included these concerns in our Significant Findings to our client, this Key Person resigned and took a position at another firm
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bankruptcy of MF Global in 2011 highlighted the potential risks associated with a Manager’s service providers.
It would be unreasonable to disqualify a startup Manager if they’ve made a business decision not to pay exorbitant fees to a Big-‐4 Auditor. In the same vein, it would be unacceptable to qualify a multi-‐billion dollar, fully established Manager that has engaged an unknown, single-‐person auditing firm with a non-‐existent client list. These relationships should reflect thoughtfulness and should be appropriate to the strategy, size and lifecycle of the Manager. Information Technology (“IT”) The most important thing to determine when examining a Manager’s approach to IT is whether or not the systems match the strategy, size and lifecycle of the fund. For example, a long-‐oriented equity fund may not require complicated IT systems, whereas a fund that values and trades in mortgage-‐backed derivatives most likely needs support from a robust system of models, technology and infrastructure. Similarly, Fund-‐of-‐Funds must have dynamic systems through which they manage their portfolios of underlying Managers and pipeline of relationships.
Evaluating a firm’s approach to IT gives us a window into how well the business is being run. While investing in technology is hardly ever a negative, the timing and magnitude of the investment is usually telling during due diligence, and must be taken into consideration when drawing overall conclusions. If a small firm with a simple strategy has over-‐invested in IT early on, and at the same time is struggling to manage its operating capital, this may direct more inquiries from our team into how business decisions are made at the firm. Likewise, a large, mature firm with a quantitative, complex strategy that has under-‐invested in IT would almost certainly warrant a more in-‐depth review of its approach to risk management.
A common mistake made by founders leaving large firms to spin out into start-‐ups is to immediately replicate the infrastructure of their previous employer. While this may project a more established platform to the marketplace, it may also shorten a start-‐up’s runway of operating capital. To be clear, we are not suggesting that start-‐ups avoid investing in technology, and if it doesn’t drain operating capital, it’s almost always a good idea. But these are business decisions that require thoughtfulness and strategic planning, and our due diligence team would be assessing these elements throughout the process.
References Typically, a due diligence questionnaire will give Managers the opportunity to provide a list of people to serve as references. While we believe it is important to verify those relationships and make every attempt to do so, it is much more critical to any due diligence process to independently utilize a mature and substantial network of industry relationships and other resources for a more candid assessment of the Manager and key persons.
References from multiple sources will prove to be valuable in drawing final conclusions about a Manager, particularly as it relates to the firm culture. Interviews should be conducted with as many service providers, clients, ex-‐employees, owners and affiliates as time can afford. A team of seasoned and experienced professionals that have spent substantial portions of their careers in the industry will be able to offer many more opportunities for useful reference checks.
Why the Qualitative Elements Matter Many elements of the due diligence process have become standardized. Advisors typically request very similar information from Managers and should generally be able to perform the quantitative analyses with equal competency. A truly robust due diligence process is distinguished from the standardized process by the qualitative analysis undertaken. Because a firm’s culture and staff personalities influence every element of the organization, a solid assessment of these less tangible aspects of a firm is paramount in working up to the most significant findings of the work.
Conducting thorough qualitative analysis requires seasoned and experienced industry professionals to examine the story told by the metrics and data, and to substantiate and in many cases, challenge claims made by Managers. Interviewing Managers and their founders, observing meetings and generally absorbing the culture of the firm can render different opinions about risks and investment viability, when viewed through the lens of experience.
Experienced professionals almost always bring a level of diplomacy to the project that junior staff cannot. This professionalism entices Managers to be more forthcoming with information. Even though due diligence can be uncomfortable and probing for a Manager, it need not be a grueling process. Particularly post financial crisis, our experience suggests that Managers appreciate
Due Diligence War Stories (2 of 2) Operations & Oversight
A Manager scored very high points in due diligence because
of their Risk Management operations.
- Manager not only had a head of Risk Manager role,
but this person was a highly compensated, senior-level
person reporting directly to the Exec. Mgmt Committee, affirming the importance of
the role internally
- The individual was extraordinarily accomplished
in the industry, and demonstrated a command
of investment portfolios, security instruments and
processes so he was well-positioned and capable of
challenging some intimidating Portfolio
Managers
- Documentation of trade ideas that were unapproved or aborted because they fell
outside of risk limits
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that they are better off in the long run when their Investor base understands the investment product thoroughly and expectations are clearly managed.
Figure 2: Lenox Park Due Diligence Dashboard4. We regularly monitor patterns that emerge as a result of due diligence findings on Fund-‐of-‐Funds, Hedge Funds, Real Assets, Emerging Managers, Private Equity and Investment Consultants. The Dashboard above is a snapshot of some of those observations.
Conclusion In our opinion, the optimal approach to Manager due diligence is one that takes into account the uniqueness of each investment opportunity, and then systematically examines the following 6 elements: Manager Background, Strategy & Performance, Fund Structure & Legal Review, Operations & Oversight, Information Technology and References. Certainly, a lot of the analysis is quantitative and reasonably straightforward. However, the distinguishing characteristic of comprehensive due diligence is an Advisor’s ability to determine how a Manager’s culture and people permeate all areas of the investment opportunity, and how that translates into the risk that Investors may take. As we’ve highlighted throughout this paper, the Manager Background and Operations & Oversight functions of Managers have warranted the majority of the time allocated during due diligence. These critical elements provide opportunities to assess whether the Manager has the talent and tools to invest capital prudently, and maintains sustainable business operations. As we purposefully dig into these aspects, there is much to gain by understanding the firm’s culture, and using this as important context for an overall assessment of the investment opportunity. Ultimately, there is no substitute for the hard work and process involved in conducting comprehensive due diligence. We believe that extraordinary work comes with highly experienced professionals on a platform that is independent and free of conflicts.
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Case Study5: The Galleon Group Raj Rajaratnam Shuts Down Galleon Group after Insider Trading Conviction
Summary6
In October 2009, a civil action was filed against the Galleon Group and its billionaire founder, Raj Rajaratnam by the Securities Exchange Commission (“SEC”) for engaging in one of the largest Insider Trading schemes in history. In the months following the action, the SEC uncovered a web of market participants instrumental in the execution and covering up the scheme, including senior executives at major corporations (Goldman Sachs, McKinsey & Co., IBM, to name a few). The investigation set in motion a series of events that resulted in the Galleon Group suffering massive redemptions from its investors and finally shutting down its business and returning all remaining capital to investors.
Firm Background
Before shuttering its doors in 2009, Galleon Group was one of the largest and ostensibly more ‘established’ Long/Short Equity Hedge Funds in the world, peaking at over $7 billion in assets under management. Mr. Rajaratnam, a former equity research analyst who later became President of Needham & Company, co-founded the Galleon Group in 1997 alongside some key individuals, including co-founder Gary Rosenbach, who also spun out of Needham. The Galleon Group managed a series of Long/Short Equity funds that primarily focused on Technology and Healthcare.
The Charges7
According to documents filed in Manhattan federal court, and statements made during the guilty pleas of some of the defendants, Mr. Rajaratnam and others repeatedly traded on Inside Information – described as “material, nonpublic information pertaining to upcoming earnings forecasts, mergers, acquisitions, or other business combinations”. Insiders at other hedge funds, public companies, investment banks and consulting firms provided the information in the form of tips relayed directly to Mr. Rajaratnam. The government built its case against Mr. Rajaratnam with wiretap evidence. Over a 9-month stretch in 2008, federal agents secretly recorded Mr. Rajaratnam’s telephone conversations. They listened in as Mr. Rajaratnam swapped inside stock tips with corporate insiders and fellow traders.
Facts & Claims of One Instance8: The Goldman Trade Facts: On September 23rd 2008, Warren Buffet agreed to pay
$5bn9 for preferred shares of Goldman Sachs. This was not announced until 6 p.m., after the NYSE closed on that day10
Before the announcement, Raj Rajaratnam bought 175,000 shares of Goldman Sachs
The next day, Rajaratnam sold his shares for a $900k profit while financial stocks as a whole fell
Claims: Rajat Gupta (at the time, a Goldman Sachs board member,
and executive of McKinsey & Co.) called Mr. Rajaratnam at Galleon Group immediately after the board meeting at which Warren Buffet’s infusion had been announced, and told him of the money Goldman expected to receive.
This information was material to the price of Goldman stock, thus inciting Rajaratnam to make the trade, something he would otherwise not have done.
Red Flags* Area of Due Diligence*
Extraordinary growth in Assets Under Management (“AUM”)
Fund Structure: Approx. $800mm to $7+ billion11 in just 7 years is lightning quick in an asset class (Long/Short Equity Hedge) that has many competitive alternatives.
Consistent out-performance of peer group
Performance: When a fund consistently outperforms its peers, particularly when the edge comes down to stock-picking, there is reason to dig deeply into the numbers, or the methods by which trade ideas originate.
The Galleon Group promoted an unhealthy culture of fear, excessive risk-taking, and gaining an information edge by any means necessary
Manager Background & References: Senior managers were known to scream and humiliate employees publicly. Traders were nervous and often humiliated in meetings. Cultural minefields as such are illuminated in on-site due diligence and by ex-employees or counterparties (broker/dealers), who should be interviewed.
Mr. Rajaratnam was very active in his Charitable & Political Donations
Operations & Oversight: Knowing where key persons choose to exert their influence is key in uncovering clubby networks that may foster illegal or distracting behavior. Much of Mr. Rajaratnam’s giving was directed toward Silicon Valley groups, where his giving may have led to expectations of reciprocity.
Prior interactions with the SEC Operations & Oversight: Mr. Rajaratnam had a history with the SEC12 in providing testimony or documents relating to others indicted for Insider Trading. Court subpoenas of employees or a fund, or any interaction – positive or negative – with any regulatory agency should be thoroughly investigated.
Weak Compliance Operations & Oversight: Many of the red flags above are not necessarily reasons on their own to disqualify a fund from being a viable investment opportunity, but together they suggest significant riskand a compliance function that is ineffective, not valued by the most senior management and ultimately failed.
*Lenox Park did not perform due diligence on The Galleon Group. Any views above are based on sources that we believe to be true.
LENOX PARK | Key Concepts for Manager Due Diligence
Jason Lamin, Co-Founder
& Managing Partner
Jason Lamin is co-founder of Lenox Park LLC and oversees all aspects of the firm’s Due Diligence Advisory business. Before founding Lenox Park, Jason was a Director in Merrill Lynch’s Fixed Income Structured Credit group in New York. In that role, Jason was instrumental to Manager due diligence for a highly selective Investor base. He began his career in Investment Banking working on M&A transactions for Financial Institutions, then helped launch a start-up group in London focused on deepening Merrill Lynch’s most lucrative institutional client relationships. Jason graduated from the University of Texas with a B.A. in Economics. At the University of Texas, he was a member of the prestigious organization, The Texas Cowboys. He is an active member of the United Nations Private Sector Forum, the World Policy Institute, Carnegie Council for Ethics in International Affairs and an active volunteer in his community in New York. In 2008, Jason founded Nyawa Funding Group, a 501(c)(3) not-for-profit organization with a mission to improve living standards in Sierra Leone.
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Endnotes 1 For the purposes of this paper, Lenox Park defines Alternative Investments as non-traditional investments that fit into the broad categories of
Hedge Funds, Private Equity Funds, Real Estate Funds & Fund-of-Funds. 2 “The Mainstreaming of Alternative Investments”, McKinsey & Company, June 2012. 3 Prequin Investor Outlook: Alternative Assets, 2nd Half 2013. 4 Lenox Park Due Diligence Dashboard: these findings are based on select due diligence mandates where Lenox Park Advisory performed due
diligence. 5 This Case Study was constructed using information available in the public domain. Lenox Park did not perform due diligence on The Galleon
Group or any of its affiliates. Any views expressed in this case study are based on materials and sources that we believe to be true and to the best of our knowledge accurately reflect events related to this case.
6 Photograph from Bloomberg News article, “Ex-Galleon Manager Spars with Rajaratnam Attorney”. March 31st 2011. Courtesy of AP Images. 7 www.fbi.gov. Press Releases from New York Field Office, February 9th 2010. “Manhattan U.S. Attorney Files Additional Charges Against Raj
Rajaratnam and Danielle Chiesi “ 8 Case Study from Seven Pillars Institute for Global Finance and Ethics. http://sevenpillarsinstitute.org/case-studies/raj-rajaratnam-and-
insider-trading-2#_ftn9. “Raj Rajaratnam and Insider Trading”. 9 Tami Luhby, “Buffett’s Berkshire invests $5B in Goldman,” CNNMoney, September 24, 2008,
http://money.cnn.com/2008/09/23/news/companies/goldman_berkshire/index.htm, accessed: July 20, 2011. 10 “Goldman Ex-Director Insider Trading Charges May Solve Long-Running Market Mystery,” CNBC.com, March 1, 2011,
http://www.cnbc.com/id/41851041/print/1/displaymode/1098, accessed March 1, 2011. 11 Reuters, “Lessons from Galleon” May 10, 2010. 12 Bloomberg, “Raj Rajaratnam’s Brother Charged With Insider Trading”, by Patricia Hurtado, Date: March 22, 2013
Lenox Park Experience
Recent clients include top-10 U.S. Public Pension Funds, a top-10 Global Financial Institution, various Foundation groups and Family Offices. Mandates include:
- Evaluate and/or implement formal internal Due Diligence policies and procedures for clients investing in Alternative Investments
- Due diligence on Private Equity, Hedge Fund, Real Asset and Fund-of-Fund Managers - Due diligence on Investment Consultants - Derivatives & Regulatory exposures
Lenox Park was an early signatory of the United Nations’ Principles for Responsible Investing (“PRI”), which aligns with the firm’s commitment to responsible business in the Investment Management industry
Firm Overview
Founded in 2009 to provide independent, conflict-free due diligence on behalf of Public & Corporate Pension Funds, Foundations/Endowments, Financial Institutions and Family Office Groups
Experienced, disciplined & principled Partners have a history of sound judgment and client-focus, with backgrounds in investment banking, audit and law
Stable of reputable service providers and a global network of industry participants
Regularly invited to participate at industry conferences as a subject matter expert in Due Diligence
Through its subsidiary, Lenox Park Solutions, the firm provides technology solutions for institutional clients
