Investors should cross-check initial explanations offered by investment managers through independent data samples, reveals SwissAnalytics analysis.

Lessons Learned:  Regulatory Cases Against Investment Managers

SwissAnalytics in its recent white paper titled ‘Regulatory cases against Investment Managers – Lessons Learnt for Investors’ highlights different basic techniques which would have helped investors to raise questions regarding their investment managers.

Category of regulatory cases

SwissAnalytics analyzed 24 regulatory cases spanning between 2000 and 2012 involving damages between USD $20 million and USD $50 billion. Broadly, it categorized the regulatory cases into three segments viz.: pure Ponzi schemes, embezzlement cases and valuation manipulations.

Ponzi schemes relate to outright frauds, usually since the inception of the fund, while embezzlement cases could involve frequent illegitimate cash transfers to the manager or related parties. Valuation manipulations involve the manger illegitimately extracting investor’s wealth through earning excessive fees based on inflated paper returns.

Useful due diligence techniques

The white paper suggests a few useful techniques that can come handy for investors while dealing with investment managers.

A strategy review would be helpful to identify and check the stated return drivers to ensure whether these can realistically explain the exhibited track record and / or the target returns of the investment strategy. The investor can conduct such plausibility checks by checking the consistency of manager’s claims in terms of risks, besides comparing the manager’s claims in terms of risk characteristics, returns, AUM and trading volume against the underlying market data and identifying other market participants.

Investors can also perform an asset and track record confirmation by obtaining confirmation directly with those counterparties claimed to be holding assets such as custodians, administrators.

SwissAnalytics’ white paper also suggests an investor seek a comprehensive documentation including marketing and statutory documents to ensure whether the business is conducted legitimately.

Investors can also perform human resources and organizational checks to validate professional abilities and ethical standards of manager’s human resources and the distribution of responsibilities within the organization. For instance, verifying professional as well as educational credentials would be helpful.

Why do investors fall victim?

SwissAnalytics’ white paper observes despite the availability of various techniques, many investors still fall victim to the perpetrators.

To obviate investors getting into such trap, the white paper suggests investors should follow up on initial explanations offered by the investment managers, irrespective of whether they may sound plausible. It suggests investors cross-check the explanations against information received from other sources, by insisting on independent data and samples. Investors should also have their thesis challenged independently to address any psychological biases.

The white paper also concludes analysis of various regulatory cases reveals that unanswered concerns should be taken seriously even if they might not serve as conclusive evidence of fraudulent behavior.