Good Risk Governance Pays

Good Risk Governance Pays

Investment Best Practices | Risk Management | Valuation

Effective Business Communications – Is Squeaky Clean Better?

Posted in Banking, Derivatives, Ethics, Financial Reporting, Investment Management, Trading

comic style illustration

During a recent conversation with colleagues about effective business communication, the topic arose as to whether it is okay to use a swear word or two in conversations with colleagues and clients. Having worked on several tradings desks at different banks, my experience likely reflects two extremes. At one financial institution, I traded foreign exchange spot and forward contracts and over-the-counter currency derivatives. As far as I know, there was no formal policy about language but the frequency with which certain four-letter words were spoken led me to believe that all was okay. Elsewhere, when I consulted with institutional investors and companies – helping them assemble hedges with futures, listed options and over-the-counter derivatives – profanity was verboten and considered déclassé at best and career-busting at worst.

In researching the topic of acceptable words and demeanor in business, with a particular emphasis on the import for the investment management industry, what I uncovered conveys a mixed bag about what makes sense when it comes to spicy utterances. According to “Why You Really Shouldn’t Curse at Work (Much),” Harvard Business Review contributor Anne Kreamer (December 27, 2011) writes that so many of us are hardened to foul language in business that its negative impact is often slight. (I think the same concept applies to the use of profanity in popular culture as well. Consider that the movie “The Wolf of Wall Street” is said to have set a profanity record with more than 500 instances of a four-letter word that starts with “f” and rhymes with “truck.”) Ms. Kreamer references interviews she conducted that support the strategic role of swearing “as an effective social tool that can enhance work relationships and allow women in particular to present an equal-to-men…identity.” Notably she cites research that bodes poorly for women who like to swear, explaining that they are often held in lower regard.

Last year, Bloomberg published the results of its review of thousands of conference calls held in the last decade and concluded that “CEO cursing spiked after the recession in 2009 and waned as the recovery strengthened.” Whether this portends an onslaught of bad words in the event of further weakening of financial markets remains to be seen. For those seeking job advice, writer Sarah Butcher provides five “golden rules for workplace cursing” (, June 14, 2013). These include the following:

  • Evaluate whether cursing is deemed acceptable as part of the organizational zeitgeist and adapt accordingly;
  • Make it about issues and not individuals;
  • Avoid sexual references;
  • If you are going to swear, do so with colleagues and not your boss; and
  • “Don’t swear if you’re a woman.”

Forbes writer Sean Stonefield goes further in “Does Swearing At Work Get The Job Done?” (June 10, 2011) by explaining that curse words may be a way to blow off steam and add humor to a difficult situation. He expounds about the power balance by asserting that managers may be able to get away with profanity when underlings cannot. His warning about litigation risk bears repeating. If someone is offended and uncomfortable as the result of a particular slip of the tongue, a lawsuit could follow.

My view is that business communication deliverables (whether written or spoken) are most effective when clear, crisp and objective. Profanity that reflects negative emotions such as anger or frustration could worsen an already difficult situation. Moreover, the use of bad language could impede the delivery of information if someone tunes out or thinks less of the errant author.

Best-selling author Mark Henshaw recommends the avoidance of questionable language as one way to advance “a more polite society,” elaborating that its use (especially when excessive) adds little to nothing to enhance the flow of ideas. He reminds readers that profanity was once rare and makes real his message by pointing out that that the 1939 blockbuster movie “Gone With The Wind” (courtesy of writer Margaret Mitchell) gave us the words that were later voted by the American Film Institute as its number one “Greatest Movies Quote.” Do you remember Rhett Butler’s line to Scarlett O’Hara? “Frankly, my dear, I don’t give a d__.”

I concur with Mark Henshaw that profanity is a faux substitute for competently conveying concepts to others and should be avoided.

Unicorns, Valuation and the Search for Investment Returns

Posted in Investment Management, Liquidity, Pension, Private Equity, Valuation, Venture Capital

Magic Unicorn seamless pattern with dots in tree different colour

Thanks to Matthew Crow, President of Mercer Capital, for an interesting analysis of regional venture capital trends. In his blog post entitled “Are VC trends the canary in the RIA coal mine?” he points out that valuations in New York, Silicon Valley and Boston are deemed by many as “too high.” As a result, venture capitalists are actively seeking potential elsewhere with a focus on generating mega returns for themselves and their institutional limited partners (“LPs”). He adds that taking equity in companies with a $1 billion plus assessment – at least on paper – may not always be the best way to generate returns when full exits are rare. The takeaway is “a growing concern that there is an emerging venture capital overhang in the public equity markets, as funds seek exits for larger investments.”

He is not alone in his prognostication. As Forbes contributor Todd Hixon wrote last year, pension funds, endowments and other LPs may be better off allocating money to smaller funds that eschew unicorns and hunt for “dragons” or “companies that return 100% or more.” As he explains in “Unicorn Hunting Is Not The Only Way To Make Money In Venture Capital,” lots of “investors in these companies are muscular funds that commit at later stages and high valuations, paying a big price for a small share.”

At least one venture capitalist is letting data do the talking. According to “Welcome To The Unicorn Club, 2015: Learning From Billion-Dollar Companies” (, July 18, 2015), Aileen Lee writes that unicorns are rare at “.14% of venture-backed consumer and enterprise tech startups.” This founder of Cowboy Ventures points out that it is seven years on average before dollars are returned to investors for the “39% who have ‘exited’ and that “surprisingly low” capital efficiency of the 61% of unicorns that remain private “will likely impact future returns for founders, investors and employees.” Click here to access an interesting graphic that shows a clear decline in the number of unicorns each year after the 2007 to 2009 period. Another visual makes it clear that e-commerce and software as a service (“SaaS”) are dominant business models for unicorns.

In a similar vein about the realities of “paper unicorns” that have not yet tested their respective price tags in the marketplace, venture capitalist Hemant Taneja, refers to the “whole valuation bubble” as “the elephant in the room.” He cautions that certain organizations are “spending money like drunken sailors” and worries that some firms “will fail spectacularly.” His bright spot is that, unlike more than a decade ago, lots of venture-backed companies are better disciplined now and can benefit from access to cheaper capital. Click here to read this week’s Silicon Valley Business Journal interview with this Managing Director of General Catalyst Partners.

In an ideal world, unicorns are dragons and general and limited partners alike can realize solid risk-adjusted returns in a timely fashion. Unfortunately, wants do not always materialize. In a December 14, 2014 update entitled “Unicorns Vs. Dragons,” authors John Backus and Hemant Bhardwaj make it clear that not all unicorns are dragons. Indeed, statistics paint a grim picture. Their analysis shows that, in the last ten years, there were only twenty-one of 339 investments, made by seventy-four different venture capital funds, that “delivered a dragon to their investors.”

For the institutional investor, the sine qua non is to distinguish between fairy tales and reality when deciding whether to allocate to a fund that invests in private companies that are expected to hyper grow over many years. Being able to sustain double digit increases in sales, cash flow and profit is challenging at best and unrealistic at worst. At a minimum, LP due diligence should include questions about an asset manager’s valuation policy, how it decides to back a particular company and whether that fund has a successful track record with public exits and other types of liquidity events. Interested readers can check out documents such as the “International Private Equity and Venture Capital Valuation Guidelines – December 2012.”

Failure to Vet Service Providers Is Risky

Posted in Compliance, Fraud, Key Person, Risk Management

Bad competition between employee. Flat vector illustration

The adage “know your customer” rings just as true when it comes to third parties that provide products and services to your business. Engaging a vendor without doing sufficient due diligence is a gamble. Every organization has its share of risks. The last thing a buyer wants is to be saddled with its problems as well as those of its seller(s). That is why it is vital for a buyer to check out how well the seller is addressing a long list of items such as technology back-up, cyber security, oversight of employees and compliance with prevailing laws. A chink in the supply chain armor can be both expensive and time-consuming for a busy executive who is already wrestling with a growing “to do” list and limited hours.

Readers of a recent survey carried out by KPMG learn that scarce resources are an impediment to vetting third parties, even when contracts include a right-to-audit provision. Authors of “Anti-Bribery and Corruption: Rising to the challenge in the age of globalization” explain that one line of defense – data analysis – is used by only one out of every four respondent organizations to assess whether it is vulnerable to anti-bribery and corruption (“ABC”) risk. Keep in mind that the problem is far from small. According to the World Bank, the “Global Corruption Industry” topples $1 trillion with no indication of diminution.

Even when information is available, language differences and variations in reporting could impede its helpfulness to a company that needs to contract with foreign entities. Additionally, numbers don’t mean much if they have been assembled under faulty premises or a resulting analysis gets thrown into a pile of documents but is never read. Consider the following. A vendor is obliged to provide an internal controls document such as a SSAE 16 report to its client. It sends the report on a regular basis. Each time a new report is received by the recipient, the unopened envelope is tossed into a filing cabinet abyss. Does that action make sense?

The takeaways are several. First, a buyer should adopt an appropriate Vendor Risk Management (“VRM”) program if one is not already in place. Second, the buyer should revise its VRM infrastructure as needed to reflect changes in circumstances. Third, the buyer needs to recognize that a failure to understand and mitigate its third party risk could lead to a disastrous outcome with potential harm to its own customers and, by extension, to its shareholders as well.

On a related note, if you missed the earlier post about corruption as applied to beneficial owners such as pension plans that do business with foreign asset managers or portfolio companies, click to read “Avoiding FCPA Liability by Tightening Internal Controls: Considerations for Institutional Investors and Corporate Counsel” by H. David Kotz and Susan Mangiero (The Corporate Counselor, September 2014).

Litigation and Due Diligence of Investment Service Providers

Posted in Litigation, Pension, Regulation, Risk Management

pensive businessman looking at the balance

According to “Firms at risk of losing pension business because of LIBOR convictions” (Pensions & Investments, August 28, 2015), the U.S. Department of Labor “is tentatively denying” certain organizations the okay to work with ERISA retirement plans. Given the billions of dollars at stake, a failure to secure a Qualified Professional Asset Manager (“QPAM“) exemption could be quite costly. In a related Bloomberg article, the point is made that a waiver was made last year for one bank with the proviso that it obtain annual audits for five years, inform pension clients of its problems and “prominently” alert the public that a “conviction jeopardized its QPAM status.”

Elsewhere, a Groom Law Group newsletter urges readers to check out DOL Advisory Opinion 2013-05A. Dated November 1, 2013, it offers guidance about criminal conduct on the part of a QPAM and/or any affiliate and regulatory requirements.

While it makes sense that a Request for Proposal (“RFP”) might preclude an organization from being considered if tainted by a criminal past, a key question is what happens if a firm has been hired and bad news follows. Unwinding an entrenched relationship can be complicated. Terminating a money manager entails transition costs. Saying goodbye to a custodian could mean months of reconciliations and systems checks with a new bank. There is no easy way to say au revoir yet that is exactly what might happen soon if certain financial institutions are not accorded a QPAM green light.

For further reading, check out:

Investment Risk Management and Making the Bed

Posted in Investment Management, Risk Management

business travel

According to the character played by actress Ellen Page in “Smart People,” everyone should make their bed each morning as it sets the right tone for the day. In contrast, her freewheeling uncle (played by actor Thomas Haden Church) offers that not making one’s bed sends a message too.

The same thing can be said about investment risk management. As an asset manager or provider of other services to investors, your creation of a robust infrastructure speaks volumes. The converse is true as well. If your proverbial “risk management bed” is unkempt, there is a greater chance of things slipping through the cracks. Should that occur, your clients will likely pay in the form of losing money or foregone opportunities. Either way, future business can suffer when it is discovered that an organization could have taken steps preemptively to mitigate risks but declined to do so.

Over time, risk management has come into its own. A multitude of companies and financial institutions have recognized risk management as a strategic imperative. Yet there are still organizations that see risk management efforts as expensive and far removed from the act of growing revenue and profitability. In my experience, this mindset is dangerous in the long-term. With a heightened awareness of their fiduciary duties, enlightened beneficial asset owners understand that effective due diligence means (a) taking a deep dive of how their existing and prospective service providers seek to tame uncertainties and (b) satisfying themselves that things are tidy and neat.

The Perils of “Sort Of” Investment Risk Management

Posted in Compliance, Disclosure and Transparency, Governance, Investment Management, Risk Management

Be Clear or Be Vague Clarity Vs Confusing Message Commuication

As someone who writes all the time, I respect words. I acknowledge that being able to communicate clearly is a time-consuming labor and requires care. For those who strive for excellence in this area, keep up the great work. For those who have fallen under the spell of soundbite gimmickry, may I suggest that you stay away from the risk mitigation team? Here is why. Unless an organization is unusually lucky, spin and ambiguity set the stage for problems such as non-compliance, inadequate controls and opportunity cost.

The “sort of” approach to investment risk management is ill-advised because it limits the ability to apprise someone of “must know” information before a trade occurs. Sadly, the airwaves and printed page are chockablock with vagueness and timid declarations. Just the other night, I heard a television commentator use the words “sort of candidate” even as he acknowledged that only one person will be nominated by each political party to run for U.S. President in 2016. Aside from being devoid of content and plain silly, the term “sort of” is highly polysemous and can lead to confusion. What exactly is a “sort of” candidate or a “sort of” trading limit or a “sort of” check and balance on bad actors or acts?

This is not to say that investment risk management policies and procedures should be rigid and uncompromising. To the contrary, there is a need for flexibility that allows for changes in facts and circumstances. With the imposition of new rules about swaps clearing, an end-user is wise to review (and revise as needed) its standing arrangements with counterparties. An expectation of rising interest rates or tighter credit availability may warrant a check on existing collateral requirements and how quality and quantity is monitored. These are two of many possible scenarios that warrant a review and possible refreshment of a prevailing modus operandi.

I am reminded of an old joke. The owner of a company tells the landscaper to get rid of the excessive vegetation outside his headquarters building. The boss returns from lunch and finds, to his great dismay, that expensive trees and plants have been removed. Nothing is left but dirt. He demands to know what happened. The landscaper retorts – “You asked me to remove the excessive vegetation.” The angry executive spits back – “I wanted you to remove the weeds.” The landscaper throws up his hands and yells – “Why didn’t you just say so?”

The message is this. There has to be sufficient lucidity about objectives, constraints, red flags and authorizations (among other factors) before investment risk management procedures can be carried out in a meaningful way. With so much money at stake and heightened enforcement about how investment risk is measured, managed and monitored, allowing a proverbial Tower of Babel to exist is a gigantic “no no.”

One Size Does Not Fit All When It Comes To Pay

Posted in Compliance, Disclosure and Transparency, Financial Reporting, Governance, Key Person, Regulation

Little feet in big shoes

At a time when skilled talent is hard to find, business executives may want to resist the urge to socially engineer. One tech company CEO learned this lesson the hard way. According to “Seattle company copes with backlash on $70,000 minimum wage” (Seattle Times, August 1, 2015), across-the-board raises to establish a minimum base salary, and the reduction of the CEO’s million dollar pay package to make it happen, have been followed by several adverse outcomes. Two key employees quit, “spurred in part by their view that it was unfair to double the pay of some new hires while the longest-serving staff members got small or no raises.” One person opined that money was given “to people who have the least skills and are the least equipped to do the job.” Several customers took their business elsewhere, “dismayed by what they viewed as a political statement.” Even though the company’s stance led to “dozens” of new clients, they will not start paying their bills until next year. In the meantime, new workers had to be hired, now at a “significantly higher cost.” Competitors are agitated, fearing that their costs will be forced upward.

How much someone gets paid continues to be a hot topic although not always for the right reasons. A few years earlier, companies such as Ben & Jerry’s and Herman Miller moved away from salary cap initiatives in order to populate the C-suite with experienced people who might otherwise not consider a move. See “Limits on Executive Pay: Easy to Set, Hard to Keep” (Wall Street Journal, April 9, 2007).

Jump ahead to 2015 and the calculus begins anew with regulations that are meant to discourage big gaps. Hot off the press, on August 5, 2015, the U.S. Securities and Exchange Commission (“SEC”) announced the mandate (pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act) that a public company now disclose how much its chief executive officer makes relative to the median compensation of its employees. Click to download the 294 page final rule about this pay ratio disclosure rule.

Not everyone thinks that government intervention will help. Financial journalist and best-selling author Roger Lowenstein articulates what some say is blatantly obvious, i.e. CEO’s earn much more than the people they manage. In “Why the new SEC rule is the wrong way to fix CEO pay” (Fortune, August 7, 2015), he points out the following:

  • Lots of people besides CEOs make big money, including popular authors, athletes and private fund managers; and
  • A pay ratio rule does little to empower investors in getting answers to important questions such as whether pay is “in proportion to the value added” and a proper alignment of shareholders’ interests with managerial incentives exists.

He rightly intimates that a pay ratio will do little to enlighten anyone about whether board member conflicts exist and, if they do, how executive compensation may be tainted as a result. His recommendation is to grant the SEC the power to let shareholders have a true “say on pay” and improve the proxy system to facilitate the installation of independent board members.

Like others, I have my doubts about the value of the compensation benchmark data. A company that relies on higher skilled workers will no doubt report a lower CEO to median pay ratio than a company with an “hourly or seasonal workforce.” So what?

As the U.S. Chamber of Commerce points out in its August 5, 2015 “Statement on SEC Pay Ratio Rule,” the metric is “misleading, politically-inspired, and costly” and “fails to provide investors with useful, comparable data.”

I am reminded of a discussion I had with another tenured professor when I taught graduate level finance. He argued that all university faculty should get the same wage until he discovered that he would be receiving less money in order for the school to pay more to others. So much for the Karl Marx dictum – “From each according to his abilities, to each according to his needs.”

No doubt, political blowhards will use newly disclosed pay ratios to make hay about their view that capitalism is “evil” because some people earn more than others. (How about those Congressional pension funds that can begin at age 50 or earlier?) Hopefully short-term hype will give way to the voice of enlightened shareholders and board members who continue to push for objective performance-linked rewards that promote long-term wealth creation.

Investment Compliance and the Nanny’s Right to Sue

Posted in Compliance, Governance, Investment Management, Risk Management, Susan Mangiero

Frau bittet um Distanz

I admit to reading the gossip magazines whenever I want a few minutes of fluff. I am never sure what is accurate but the stories make for five-minute intrigue. One recent example says it all. In a not so private tussle, an alleged affair between the husband of a Hollywood power duo and the couple’s nanny underlies their recent divorce announcement. What caught my eye is a statement that the nanny was fired by Mrs. Mover and Shaker and has “met with attorneys to file a wrongful termination suit” against the wife since it was the mister who technically hired her. If true, the drama has Nanny contributing to a faux pas writ large and then blaming someone else for her questionable behavior. For the legal issues, I defer to the attorneys who no doubt will make the appropriate arguments for both sides. From a governance perspective, I am reminded once again that contracts count.

Over the years, my work as a forensic economist and testifying expert increasingly looks to issues about who is contractually versus functionally tasked to do what, when and on what basis. Sometimes the primary allegation (and related work in calculating damages) is tied to contractual breach and not fiduciary breach. As a consultant, when I have had to negotiate business contracts, I typically spend considerable time with counsel. After all, a contract is meant to codify both commercial and legal terms and conditions. In other words, contracts are serious bits of paper.

Last year, I wrote about the importance of the fine print. In “Brown M&Ms and Investment Service Provider Due Diligence,” I described musician David Lee Roth’s approach. Apparently, each of Van Halen’s agreements includes “a rider … designed to force a promoter to pay attention to the band’s true objective about ensuring safety.” By including a provision to only stock certain candies in the dressing room, the goal is to have everyone read the entire contract and carry out all requirements, including the proper installation of equipment. No brown M&M candies is their red flag to further question the concert producer about risk management.

In the investment world, ideal contracts between institutional investors such as pension plans and their service providers are those which, at a minimum, are explicit, include easy-to-assess performance metrics and are well understood by both buyers and sellers. Otherwise, a dispute is possible.

Regarding the nanny, it remains to be seen whether she can file a tenable lawsuit. While seemingly upside down on its face, she might technically have the right to seek redress if her employment contract stipulates that romantic interludes with hubby are outside the scope of how “cause” is determined. One thing is for sure. The presiding judge will have a front row seat to an unfolding drama that goes beyond celluloid.

Trust, Ted and Norb Vonnegut

Posted in Ethics, FINRA, Key Person, Regulation

Trust icon

Having just signed up for a forthcoming webinar about the U.S. Department of Labor fiduciary proposal, trust is on my mind. Due to a recent introduction of like-minded advocates for good process, I had a chance to watch a TED Talk with Mr. Norb Vonnegut. (For those who have not had the pleasure, there is a large volume of interesting videos, courtesy of the Technology, Entertainment and Design nonprofit organization that began in 1984. Click to read about TED.)

During his talk entitled “How Do You Know You Can Trust Somebody With Your Money?“, Mr. Vonnegut asserts that individuals should be wary of relying too heavily on a financial organization’s brand. Even if a regulator like FINRA or the U.S. Securities and Exchange Commission has the purview to oversee a financial advisor or other type of intermediary, budgetary resources do not allow for examinations of everyone they regulate.

Mr. Vonnegut illustrates his cautionary tale for investors with a scary snapshot of a neighbor gone bad – someone who was running a Ponzi scheme and was eventually arrested and jailed. He urges investors to avoid wealth management “helpers” who appear conflicted or boast a troubled background, adding that one can handily visit as a first stop.

Given his many years as a senior financial advisor and now a successful author and journalist, Mr. Vonnegut recommends that investors download the Fiduciary Oath from his website and then do plenty of homework rather than relying blindly on name or where someone went to college.

Insights on Economic Analysis of Fiduciary Monitoring Disputes

Posted in ERISA, Fiduciary Liability, Investment Management, Litigation, Regulation, Susan Mangiero

Lee Heavner_Susan Mangiero

While I typically avoid republishing posts from my other blog, Pension Risk Matters, there are numerous topics that are important to all types of investment industry professionals and not just those who work with retirement plan sponsors and participants. One such topic looks at investment monitoring and the fiduciary responsibilities to oversee and make changes, as needed. Recently, the U.S. Supreme Court applied its judicial experience in opining about the relevance of how long to monitor investments for a trust fund such as an ERISA plan.

While there has been no shortage of informative write-ups by attorneys about this headline-ripping case, little had been written by any forensic experts until now. To fill this void, I wrote “An Economist’s Perspective of Fiduciary Monitoring of Investments” (Pensions & Benefits Daily, May 26, 2015). The interest in the topic of damages and the complexities of when and how to monitor led to a second article.

According to a recent Business Wire press release about these follow-on insights, “Economic Analysis in Fiduciary Monitoring Disputes Following the Supreme Court’s ‘Tibble’ Ruling” (Pensions & Benefits Daily, June 24, 2015), Dr. Lee Heavner (Analysis Group Managing Principal) and Dr. Susan Mangiero (Fiduciary Leadership, LLC Managing Director) explain that what constitutes a reasonable monitoring process may be influenced by plan- and investment-specific factors, as well as by the expected benefits and costs of different monitoring activities. They are quoted as saying that “The monitoring of investments is a broad and complex topic. There is no uniform process that is appropriate in every situation. To the contrary, the list of potentially relevant risk factors is long and subject to revision as circumstances change.” These two economists (both of whom have worked as expert witnesses) also discuss how complexities arise when calculating economic damages due to the wide array of alternative actions and the substantial variation in timing that may be consistent with a prudent monitoring process.

Click to read the U.S. Supreme Court May 18, 2015 Tibble opinion. Jurists emphasize the significance of the topic of investment monitoring for both buyers and sellers of financial products and services.