Good Risk Governance Pays

Good Risk Governance Pays

Investment Best Practices | Risk Management | Valuation

How to Be More Transparent With Your Investment Clients

Posted in Compliance, Disclosure and Transparency

Investigation text on typewriter

I’m only a few pages in but, so far, Reacher Said Nothing: Lee Child and the Making of Make Me by Andy Martin is an entertaining read. Drawn to this new book in my quest to learn how bestselling writers write, I am impressed by Mr. Child’s uncanny ability to create. After a successful career in British television, Lee Child triumphed with an award-winning first novel entitled Killing Floor, followed with sixteen more popular offerings. Forbes describes Child’s protagonist, Jack Reacher, as a “billion-dollar brand” with 70 million books (and counting) in print. It’s no surprise then that whatever Lee writes, people are likely to read. I’m one such person.

I happened on his New York Times essay entitled “A Simple Way to Create Suspense” (December 8, 2012) and wondered whether the art of thriller writing lends itself to fund manager communication with investors. My conclusion? No. Here is why.

As Mr. Child astutely instructs, you make your family hungry by having “them wait four hours for dinner.” You tease your readers by asking a question or inferring a nugget of information at the outset and then wait to close the loop until later on. His premise is that “Readers are human, and humans seem programmed to wait for answers to questions they witness being asked.” Once the television remote control device appeared on the scene, it was even more necessary to keep viewers from jumping ship.

I believe that the opposite is true when applied to how a fund company, bank or financial adviser should share knowledge with its clients. You don’t want them to be digging around in search of needed information until the “end of the book.” For one thing, regulators continue to push for transparency and straightforward language. Then there is the reality that, absent costs that make it too expensive to terminate, investors who don’t get their questions answered may go elsewhere. Another detriment of building suspense in your investment communiques is that too much ambiguity could discourage your clients from further transactions. If they can’t understand what’s going on with their portfolio, it’s going to be tough for them to decide what to buy or sell. Whether you receive fees or commissions, asset size impacts your revenue. Add to the mix the fact that busy people are impatient for news about their money and want customer service that takes their schedules into account.

Red herrings and drawn out plot points have their place in nail-biting novels but not when it comes to enlightening institutional and individual investors.

Investment Advisors, Monitoring and Compliance

Posted in Fiduciary Liability, Governance, Investment Management, Regulation, Risk Management

exotic yellow tennis ball as sport background

I talked last week about the intricacies of investment monitoring as part of a Bloomberg BNA webinar entitled “Life After Tibble: Investment Monitoring and Litigation Defense Considerations for ERISA Fiduciaries.” One of the points I made, repeatedly I might add, is that it is critical to evaluate the facts and circumstances related to a specific situation.

A few days later, I was asked by a journalist to give a thumbs up about a particular investment strategy. I reiterated the same message to him, explaining that it would be impossible to make a blanket statement that X is right and Y is wrong without understanding what an investor seeks to accomplish (among numerous other factors). As he pushed for a simple answer in a vacuum (which I was reluctant to give for obvious reasons), I kept thinking about the tennis ball on a string that my husband installed in our garage. The idea of this nifty technique is to remind me how far I can advance with my car and know with confidence that I have enough space to avoid bumps or scratches.

There are no uniformly shaped “tennis balls” to guide investors to a perfect landing each time they “park” their car. To the contrary, adopting an overly simplistic approach may be ill-advised. Pay attention to what regulators such as the U.S. Securities and Exchange Commission (“SEC”) say.

In its November 9, 2015 National Exam Program Risk Alert, the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) shares its observations about Chief Compliance Officer (“CCO”) outsourcing based on investigations of some 20 SEC-registered investment advisers and investment companies. The long list of concerns include the following:

  • Personal interaction between the outsourced CCO and advisory firm employees led to a “better understanding of the registrants’ businesses” than relying on a checklist approach and electronic communication;
  • “More significant compliance-related issues were identified at registrants” when its external CCO lacked sufficient staff;
  • When an outsourced CCO was able to independently obtain requisite information, annual reviews were deemed more accurate than when the third party relied mostly on data provided by the investment advisor;
  • Generic risk checklists used by CCOs “did not appear to fully capture the business models, practices, strategies and compliance risks” of the registrant; and
  • Generic compliance policy and procedure templates used by outsourced CCOs were, in some cases, “not appropriate or applicable to the registrants’ businesses or practices.”

No matter how you slice it, the theme remains the same. Be diligent and consider the information that is germane to the investing or business activity situation at hand. There is a good lesson for investors as well. Ask whether an outside compliance vendor is used. If the answer is yes, dig deep about the rigor applied by that outsourced CCO, perhaps even ask to talk to the outsourced CCO used by the investment advisor and query about how risk is assessed, by whom and how often.

Creating A Business Plan for 2016 – You Are The Product

Posted in Career Development, Susan Mangiero

Breakfast Cereal

As we move into 2016, I’ll be putting the finishing touches on what I call the business plan for Susan Mangiero. It’s something I do each year in large part thanks to advice from a senior banker who was my boss when I started out in finance. His belief was that everyone should liken themselves to a bowl of breakfast cereal every twelve months and figuratively examine issues such as whether to add more “raisins,” repackage the product, market a “new and improved” version or stay with what works if that’s the case.

My dad (who is sadly no longer alive) had a similar perspective about retooling as the market dictates. A former space engineer who helped design one of the early weather satellites, he later contributed to the building of important medical devices. A true role model, he walked the walk by returning to school in his fifties to learn Computer Aided Design (“CAD”) and Computer Aided Manufacturing (“CAM”). His rationale was that the world had changed, enhanced skills were now needed and he would not be able to compete unless he added to his skill set.

Some experts suggest combining a life plan with a business plan, especially if you are an entrepreneur or professional who spends a lot of time blurring the lines. I think the key is to get started, even if it means taking incremental action. Dr. Robert Maurer extolls the virtues of this approach in his bestselling book “One Small Step Can Change Your Life: The Kaizen Way.” In “How to Plan Your Life, When You Can’t Plan Your Life,” Forbes contributor Paul B. Brown pushes individuals to stop wasting time in search of the perfect job and instead “create it – either within an existing organization” or as a new enterprise. Daniel Pink is another advocate of recognizing that we are THE product, whether our clients are fellow employees or outside parties. Actor and investor extraordinaire Ashton Kutcher is wise to acknowledge that “…opportunity looks a lot like hard work,” saying that “… every job [he] had was a steppingstone to [his] next job…”

The great thing about working in the investment industry, if you embrace challenge, is that there is always an opportunity to apply existing skills and experience to new situations. Rules change. Market conditions vary. Institutional investor objectives and constraints may be modified to reflect a need for enhanced returns or liquidity or whatever makes sense.

Staying current is important and is one of the reasons why I regularly surpass the continuing education minimums for various designations I hold by speaking, teaching, writing and attending workshops given by others. (It is likewise important for my work as an expert witness.) In 2015, I studied and then successfully passed the requisite exams to become a Certified Fraud Examiner. (I had already met the experiential requirements.) I’ve assembled data for a business book that I am writing in my free time. I’m adding to my database of investment litigation research. On a personal note, I want to allocate time to exercise more, get better at playing bridge and catch up on books that I bought and have not yet opened.

As you write your 2016 plan, have fun, think big and ponder the “raisins” you need and want.

Puerto Rico and Its Bondholders

Posted in Credit Risk, Hedge Fund, Investment Management, Litigation, Municipal Bonds, Susan Mangiero

Piggy bank drowning in debt - savings to risk

After a round of holiday hellos during dinner with a group of friends, the conversation turned to Puerto Rico and its financial distress. One gentleman at the table has a lot of his 401(k) account invested in municipal bonds, including a hefty allocation to Puerto Rico. Naturally he is nervously watching events and hoping for the best. From his perch, he finds it incomprehensible that retirees would be left holding the proverbial bag and strongly believes that his Puerto Rico investments are safe.

Although the situation is fluid and therefore subject to change, the essence is that this U.S. territory is facing a severe cash crisis and may need to restructure its estimated $70 billion in debt. Filing for Chapter 9 protection from creditors will depend in part on U.S. Congressional approval. Creditors are not happy and likely to be less so if attempts to seek redress (if they don’t get paid on time) in court are thwarted. See “Bills Halting Litigation Over Puerto Rico Debt Raise Legal Issues” (Lynn Hume, The Bond Buyer, December 23, 2015).

Some believe that allowing a bankruptcy filing is neither necessary nor helpful. According to “Puerto Rico’s utility reaches tentative agreement to restructure $8.2B debt” (Robert Walton, Utility Drive, December 21, 2015),  MBIA Inc. and Assured Guaranty Ltd. are willing “to take a 15% loss on what they are owed.” If approved, this arrangement would free up resources to modernize the power infrastructure in Puerto Rico and demonstrate that negotiations are possible. In his piece for Forbes, energy consultant Steven Fetter predicts three adverse outcomes should Puerto Rico file for bankruptcy protection. They are as follows: (1) reduced access to capital (2) higher costs of borrowing required by those lenders who are willing to take the exposure and (3) greater difficulty for retail investors to recoup principal and interest. See “Filing For Bankruptcy Isn’t The Right Solution For Puerto Rico” (November 29, 2015).

Regular readers of Good Risk Governance Pays know that my other analyses about municipal bond investing have focused on unfunded liabilities, disclosures and liquidity. As I wrote in “Muni Bonds, Pension Liabilities and Investment Due Diligence” with Dr. Israel Shaked and Mr. Brad Orelowitz, having sufficient information about a municipal bond structure is so important that the U.S. Securities and Exchange Commission (“SEC”) has ratcheted up its enforcement efforts in this area. Co-presenting with senior attorney Elaine Greenberg as part of an educational program for the Practising Law Institute, I put forth a long (but not exhaustive) list of “must know” items that an investor would reasonably require before purchasing a particular municipal bond or municipal bond fund. When contract terms or economic circumstances change, an investor wants to know how he or she is likely to be affected so that a decision can be made to buy or, if possible, sell.

One change that worries some Puerto Rico bondholders is whether they are subsidizing payoffs made to others at their own expense. In his December 27, 2015 piece, Wall Street Journal reporter Aaron Kuriloff describes how sales tax revenue that has been earmarked to pay off IOUs issued by the Puerto Rico Sales Tax Financing Corp.(“COFINA”) may instead be diverted to pay holders of Puerto Rico’s general-obligation debt on January 1. Click to read “‘Safe’ Puerto Rican Debt Stirs Worries.” As CNBC’s Dawn Giel points out, there are serious questions about whether this kind of clawback is permitted. See “Puerto Rico takes dramatic step to avoid default” (December 1, 2015).

As this crisis unfolds, there are lots of questions that need answers. A few are listed below.

  • How did investors reevaluate credit risk each time that Moody’s Investors Service downgraded Puerto Rico general obligations bonds to below investment grade?
  • What information was disclosed to investors by issuers and when?
  • Will the value of bond insurance be degraded as part of any restructuring?
  • What is the market for uninsured bonds such as the $750 million that was issued by the Puerto Rico Aqueduct and Sewer Authority (“PRASA“) earlier this year?
  • How will the presence of large mutual fund and hedge fund bondholders such as Oppenheimer Funds, Franklin Templeton, Perry Capital and Monarch Alternative Capital influence the restructuring discussions?

The next repayment date is right around the corner. Stay tuned.

Business Ethics and Enterprise Value

Posted in Ethics, Governance, Risk Management, Valuation

Business Ethics and flat design illustration concepts for business analysis, planning, consulting, team work. Business Ethics concepts for web banner and printed materials.

Good corporate behavior gets a thumbs up from bestselling author Seth Godin. As he writes in “Business ethics, ripples and the work that matters,” high integrity can shine up a company’s brand, help to attract talented workers and add to shareholder value. Any fiduciary who ignores this call to “goodness” may be in trouble.

Godin’s view is hardly unique. A stroll to the Ethical Systems website yields a long list of books about the economic advantages of abiding by a certain code of conduct. Executives regularly request appraisals of brands and other kinds of intellectual property as a way to verify value. The goal is to enlarge the long-term piggybank.

Where Godin differs somewhat from data-driven researchers and other number crunchers is his emphasis on doing the right thing at an individual level since “only people can have ethics.” The import of this statement is considerable. Too many times, critics question for-profit organizational decisions and actions as if corporations are amorphous structures that exist to destroy. An advocate of free markets, Nobel Prize winner Ronald Coase raised high the concept that a corporate structure enables individuals to effectively contract with one another. A related premise is that agreements with persons such as an employer and employee will only work when there is trust and confidence that contracts (whether explicit or indirect) will be honored. Should an actual or perceived breach arise, the courts play a vital role by providing a venue for each party to seek redress.

Godin is warmer and fuzzier than most when he exclaims “You either do work you are proud of, or you work to make the maximum amount of money. (It would be nice if those overlapped every time, but they rarely do).” I don’t necessarily agree that the twin pursuits of maximum gain and investor satisfaction are mutually exclusive unless Godin means that there is a cost associated with making investors, customers, employees and vendors happy. If that’s the case, I concur. An important issue is how much it will take to be a good steward of other people’s money and remain one thereafter.

As we prepare our list of resolutions for 2016, mirror-gazing through a Godin lens could make sense for those who want to better like what they see.

Governance, Risk Management and Compliance (“GRC”) and Nasty Colleagues

Posted in Compliance, Investment Management, Regulation, Risk Management

shark biting a dollar currency sign, 3d illustration

Effective Governance, Risk Management and Compliance (“GRC”) critically depends on the hiring, retention and oversight of talented and ethical professionals. These individuals don’t need to be best friends. To the contrary, a risk manager must be tough and able to say no to traders and deal-makers if their individual or collective activity jeopardizes enterprise value. Sometimes this is easier said than done, especially when bonuses and other forms of compensation encourage excessive risk-taking. Dealing with difficult personalities doesn’t help. Worse yet, bad behavior can cost a business a lot and lead to headaches.

In their just-published paper entitled “Toxic Workers,” Michael Housman and Dylan Minor explain that the types of employees who can harm “organizational performance” share certain traits that can be screened as part of the recruiting process. Overconfidence in one’s abilities and an obsessive focus on adhering to rules are two such indicators. Once hired, toxic workers tend to be extremely productive and can therefore inhibit an employer from dismissing them. The two researchers write “For example, an investment bank with a rogue trader who is making the firm millions in profits might be tempted to look the other way when the trader is found to be overstepping the legal boundaries.”

Unfortunately for firms that prefer to look the other way, regulators may force their hands to mitigate what is known as conduct risk or the behavioral dimension of operating a financial institution. Authors of Thomson Reuters’ “Conduct Risk Report 2014/15” cite multiple examples by country or regional regulators to include the following actions:

  • Fines imposed on a firm that had inadequate supervision of customer sales (US);
  • Fines imposed on a firm that failed to detect anti-money laundering violations (US);
  • Fines imposed on a firm that executed customer trades at “inferior” prices (US);
  • Fines imposed on a trader that did not disclose conflicts of interest to his bank employer (UK);
  • New rule about remuneration paid to senior managers (Eurozone);
  • Review of corporate governance practices (Middle East); and
  • Suspension of financial firm’s license for IPO sponsorship (Hong Kong).

In that same study, survey-takers divulge key ingredients of conduct risk to include, among other things, culture, ethics, integrity, sales practices, bribery, corruption, incentives and conflicts of interest. It does not take a genius to understand that conduct risk is a function of having a labor force of humans who could do bad things when controls are non-existent or inadequate and/or incentives are perverse.

In 2016, expect a heightened focus on conduct risk, the strategic role of Human Resources and a prominent seat at the table for the Chief Risk Officer. A read of Ernst & Young’s “Rethinking Risk Management” affirms conduct risk as a “top concern” of board members and senior executives, along with a continued focus on developing a strong risk culture and a good tone at the top. This all sounds like a propitious way to begin the next twelve months. After all, one cannot manage risk unless it is recognized.

Duck Humor and Investment Risk Management

Posted in Risk Management

Illustration of happy duckling waving wing

A duck walks into a store and asks the man behind the counter if he has any candy. The storekeeper says “No, we don’t.” Twenty four hours later, the duck returns to the store, asks the same question and gets the same answer. He repeats this activity daily with unchanged results. After a week, the owner has had enough of time wasting and tells the duck “If you come in here and ask that silly question again, I will hit you on the head with a hammer.” The next day, the duck saunters in and casually asks “Got a hammer?” When the man says “No,” the duck asks “Got any candy?”

I laughed when I first heard this joke. So far, I am getting laughs even when some listeners anticipate the punchline. Chuckles aside, there is a lesson here about the folly of repetition.

Albert Einstein describes insanity as “Doing the same thing over and over again and expecting different results.” This repetition tendency is a reality in today’s investment management world and presents itself often. Consider a few examples.

Many pundits have pushed for money management compensation schemes that are designed to discourage traders from taking on too much risk yet losses related to breach of limits or rogue activity in search of big bonuses still occur. Best practice advocates have urged the hiring of independent third parties to vet “hard to value” marks but regulators continue to investigate “enough” instances of inflated numbers, opaque processes and overly complex models that are difficult to test. Despite the fact that past is seldom prologue, there is still an over-reliance on historical numbers, even when it is clear that future returns are likely to be dramatically different. A change in regulations, competitive structure and/or composition of the key person team are a few of the factors that could drive a wedge between realizations and expectations.

Mr. Duck may never get his candy but savvy investment risk managers know better than to dance around in circles when their investors want them to move forward.

Investment Managers and the Creativity Factor

Posted in Investment Management

Portrait of young businessman with toy paper wings. Success, creative and startup concept. Copy space for your text

According to yesterday’s New York Post, adults can’t get enough of coloring books for themselves. In the last two years alone, this genre has seen more than 2,000 publications. The two most popular have sold nearly 14 million copies in fifty countries. A trip down memory lane is one factor. Others declare that coloring relieves stress in much the same way as meditation does but without the added pressure to be productively creative and not silly. An article in Medical Daily extols the healing power of any activity that encourages concentration. A piece in The Atlantic entitled “The Zen of Adult Coloring Books” describes the virtue of a predictable outcome in contrast to the uncertainty and related stresses of life.

In the investment industry, stress and uncertainty are constants. It is important to have a way to relax and let off steam. Coloring inside the lines may be helpful and fun after hours but creativity should be unwrapped for business purposes too. Forbes contributor Brett Steenbarger writes that those asset managers who are skilled at being creative are more likely to avoid the trap of groupthink. They are better able to connect the dots and identify macro trends that others miss. He credits Michael Michalko, author of Thinkertoys: A Handbook of Creative-Thinking Techniques (2nd edition), for urging people to be open-minded and playful when trying to solve problems at work.

This emphasis on creativity with a capital C makes sense to me. In my work as a forensic economist and expert witness, the core principles of finance, fiduciary duties and compliance remain but the facts and circumstances dictate the kind of data that should be examined and the nature of the analysis and investigation that should ensue. An investment manager has the same challenge of trying to make sense of all relevant information rather than relying on a “one size fits all” approach. Financial advisors likewise need to take into account a myriad of factors such as individualized client goals and restrictions. Looking at the world with the same weary lens is ill-advised, especially at a time of seismic change in terms of capital market regulation and investment industry competitiveness.

Maybe it’s time to add crayons and Play-Doh to the office supply inventory as a way to inspire new ideas.

Enterprise Risk Management and Shareholder Value

Posted in Risk Management

Pencil Tug of War_80521276_XS

As I recently told a group of graduate university students, don’t expect to be the life of the party if you are a risk manager. Colleagues will likely balk when you ask them to take time from already busy schedules to pull together deal details, trading notes and other documents that you need to review, verify and possibly use for restructuring. I further explained that a “tone at the top” orientation in favor of risk mitigation can mean the difference between success and failure. This is especially true if an organization is unduly focused on cutting short-term expenses and perceives risk management activity as a cost sink. Fortunately, at least some businesses see things differently. Their view is that effective risk management can protect or even enhance shareholder value and should therefore be pursued in a big way. Results of a recent study reinforce this notion.

Sponsored by Aon Global Risk Consulting, a survey of over 1,400 corporate executives reveals that damage to reputation or brand is ranked number one of ten “formidable risks.” Other risk factors include, but are not limited to, the following:

  • Anemic economic growth;
  • Regulatory and legislative changes;
  • Greater competition;
  • Difficulty in attracting and retaining talented workers; and
  • Cyber threats.

Notably, the point is made that many of the cited fifty-three risk factors are interrelated with others. The implication is that a risk management team should include persons with various backgrounds. My professional experience bears this out. I’ve frequently worked on teams that include job functions such as auditing, compliance, legal, trading and technology.

The interconnection of risk factors is an important reason why companies need to have a strong risk culture. Tackling complex risk issues requires resources. When leaders understand this, it is a lot easier to budget for enterprise-wide training, procure technology and encourage employees to work together.

“Pajama Head” Investment Management

Posted in Investment Management

Senior man in pajamas with teddy bear isolated in white

In the last few months, I’ve noticed a focus on dressing nicely for work. The female CEO character in “The Intern” admonished her tech employees to leave the tank tops and jeans at home. Ad campaigns of handsome men in tailored suits appeared in volume after “Fifty Shades of Grey” hit the big screen. Even in the small town where I live, a local restaurateur posted a sign on the door that puts hungry persons on notice – “No backward baseball caps or excessively baggy pants are allowed.” When I acknowledged the sign to the owner, he launched into a diatribe about sloppiness and his goal to promote a certain ambiance. A week later, in response to a friend who mentioned that many of her students are getting tattoos, I remarked that plentiful body ink might be a deterrent to getting a job in finance. While she disagreed with me, several career experts recommend a clothing cover-up if applying for a position in a “typically conservative industry such as accounting or banking…”

I know about clothing rules firsthand. When I first began my career in financial services, the head of the bank credit training program pulled me aside and told me that wearing brightly colored tights would keep me from having a successful career. She strongly suggested that I stick to beige stockings instead. During my tenure with a Fortune 50 company, working as part of a risk management compliance team, the Treasurer gave me the task of telling the outside technology consultant not to return until he purchased (and wore) socks.

In contrast to sartorial trendsetters, there are those who go to the opposite extreme by dressing as if everyday is Casual Friday writ large, much to the chagrin of managers who are trying to set a more disciplined tone. While each industry has its own unique standards for what constitutes an “appropriate” wardrobe, some suggest that client-interfacing professionals in the investment management industry should dress to impress. Outside of recreational events such as golf outings or meetings with venture capitalists who live in khaki, how many investment committees want their asset manager, banker, consultant or advisor to arrive for a presentation wearing gym pants and a tee shirt? The other perspective is that someone who shows up with a Rolex or high-price outfit could discourage a sale with a would-be institutional buyer who gets paid a modest salary and buys off the rack.

Some individuals look beyond the visuals, asserting that slovenly or slapdash costuming can lead to sloppy thinking at work. As a result, promotions and getting new clients may be slow to come about. According to the Ladders career website, one needs to “appear polished and ready for the next challenge.” A Psychology Today article goes further, with its author, Dr. Ben Fletcher, writing that “our clothes say a great deal about who we are and can signal a great deal of socially important things to others, even if the impression if actually unfounded.”

Aside from legal issues relating to allowable clothing, a topic I leave to attorneys, I hope I’m right that a trend towards formality is emerging with regard to both dress and courtesy. Reuters is not singular in its message that “good manners will open doors that the best education cannot.” Did you know about the annual celebration called “Bring Your Manners to Work Day?

Even as research about protocol and appearance continues, those in the investment management industry should embrace opportunities to be seen as professional and competent. There is a certain intimacy about decisions that involve money and investors want to feel good about their service providers, especially now. According to the 2015 Edelman Financial Services Trust Barometer, there is a keen need for more assurances about the integrity of this industry. When buyers don’t trust, they don’t buy.

Said differently, don’t be a “pajama head” when it comes to wardrobe and demeanor.