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Hurt hedge fund servicer tightens up procedures

Date: Monday, May 17, 2010
Author: Steve Johnson, Financial Times

Making a multi-million dollar settlement to resolve a legal dispute with a former client can be a painful process, particularly when it pushes a company into a full-year loss.

But GlobeOp Financial Services, the London-listed hedge fund administrator, is convinced its costly tangle with Regents Park Capital Management has improved it as a company and provided spin-off benefits for investors across the hedge fund industry.

“That which doesn’t kill you makes you stronger,” says Vernon Barback, president and chief operating officer. “The lessons learnt have come back to be very valuable assets for us.”

In its full-year 2009 results, GlobeOp recognised a pre-tax provision of $43.5m, some $27m after tax, to settle a legal dispute with Regents Park which arose in 2004 and 2005. The settlement pushed GlobeOp to a pre-tax loss of $19.2m, compared to a pre-tax profit of $38.7m in 2008.

The settlement related to GlobeOp’s “obligation to calculate and distribute the net asset value of the fund and the impact on that of mis-priced position values provided by a principal of the hedge fund’s investment manager”.

The UK’s Financial Services Authority said it appeared, over a number of months, that “there was a discrepancy between the realisable value of certain investments and those valuations provided by Regents Park”.

Jae Wook Oh, chief executive and senior partner of Regents Park, agreed with the FSA in 2006 not to undertake any control function in relation to regulated activities for the next three years, although the FSA made no finding of misconduct against any individual.

Stung by the pay-out, and also a 2007 settlement with Archeus Capital Management, which blamed its decline from $3bn of assets under management to $700m on what it alleged to be GlobeOp’s failure to maintain accurate records, claims denied by GlobeOp, the company has strengthened its procedures. “Expensive as the settlement was, with hindsight we learned a lot of things that placed us in a good position,” says Mr Barback of the Regents Park saga. “We have put in a number of checks and balances and changes in our technology.”

One concrete step was to institute a fair market value committee. GlobeOp is responsible for confirming the value of fund assets, which may be straightforward for many assets but more problematic for highly illiquid holdings such as private equity or lightly traded privately placed debt.

Despite the Regents Park episode, the company is adamant that manager marks – where the fund manager provides valuations of their own holdings – are still acceptable, provided they are consistent with the internal valuation policy GlobeOp is increasingly insisting its client funds have.

“Manager marks, I think, are legitimate, providing the investors and their representatives on the board of the fund are aware of the extent of them. It may not be possible to obtain independent prices or to calculate them,” says Mr Barback.

“It’s our responsibility to follow the pricing policy of the fund. It is good practice for a fund to have a written valuation procedures manual that should be available to investors.”

Not that encouraging the oft opaque hedge fund industry to adopt transparent valuation policies has always gone smoothly.

“Some funds find it a challenge to have a well-defined valuation policy, but I explain to them that it’s for their own good,” says Tom Kirkpatrick, head of enterprise risk management at GlobeOp. “Ultimately they understand that good governance will attract more investment.”

Any difficulties in pricing assets are escalated to the fair value committee, chaired by Mr Kirkpatrick and GlobeOp’s general counsel, which meets twice a week.

If agreement cannot be reached with a fund manager, GlobeOp will tell investors that it has been unable to verify a price.

This is just part of a rich array of information that GlobeOp now disseminates directly to fund investors.

According to Mr Kirkpatrick, prior to the Bernard Madoff debacle and the wave of suspensions and gates that blighted the industry in 2008, all investors typically received from an administrator was a statement of net asset value and “maybe some performance information”. However, investors are now demanding more information, he says,

To that end, GlobeOp is now producing operational risk disclosure reports that outline not just the NAV and the proportion of assets GlobeOp is able to independently confirm the pricing and existence of, but also lists the proportion of assets exposed to counterparties such as prime brokers and the entities it has traded derivatives with.

The reports also provide a breakdown of the liquidity of each fund by outlining the volume of assets that fall into a series of liquidity categories, as defined by the FAS 157 accounting standard.

Again, the process has not been straightforward, with Mr Kirkpatrick saying a “delicate balance” has had to be struck between investors’ desire to have greater transparency and fund managers’ sensitivity to revealing their positions to a wider audience.

“We have established a baseline of the type of data that investors have told us is valuable and is of a high enough level to get a snapshot without compromising managers’ positions,” he says.

To some extent GlobeOp has been unfortunate in having to air its dirty linen in public – most of its peers are either private companies or are small divisions of large banks and thus do not face the same level of scrutiny.

But Mr Barback believes the Regent Park episode has actually helped drive its growth, which saw assets under administration rise 24 per cent to $109bn in the year to December 2009, outstripping the growth of the underlying industry.

“Writing a cheque of that magnitude was not pleasant, but long before we wrote the cheque we had internalised the lessons and we put in place procedures, technology and training that has allowed us to expand our business mightily,” he says.