Money matters

THE CORPORATE GOVERNANCE MODEL

admin — Sun, 01 Nov 2009 14:59:11 +0000

Corporate governance has moved forward from earlier carte blanche control structures. Different management structures have been examined, and changes will be inevitable through regulation or internal pressures for reform. Mandating the money immediately without control or lien is a bad idea and one that has fallen out of favour in fund management. Control by a more proactive group of trustees, an elected board of non-executive directors and more effective risk-burden sharing is on the cards. Tie everyone in and knot tightly to secure corporate loyalty and performance.
Governance capability levels show some ways in which we can exercise more control over the CEO and investment manager. ‘. . . the Sarbanes-Oxley Act is a call to get back to the basics that we have been discussing. Simply stated, the current status quo for corporate governance is unacceptable and must change. . . . The message for chief executive and chief financial officers and senior management is: Uphold your responsibility to maintain effective financial reporting and disclosure controls and adhere to high ethical standards. This requires meaningful certifications, code of ethics, and conduct for insiders that, if violated, will result in fines and criminal penalties, including imprisonment.’ We have shown some of the models for reforming and monitoring the fiduciary duty of the board of directors and investment managers. Organic risk management plays a valuable role here by asking what is the value of leadership – i.e. stripping away performance from perceived reputation. These models have the potential to move us into the light rather than signing your money away and being left in the dark.

REPUTATION RISK

admin — Mon, 26 Oct 2009 14:57:58 +0000

A move from living off yesterday’s reputation is gradually taking over the market. One failure has come from the “best of breed” philosophy for hiring the best and paying the most. This attitude has been severely tested in an era of underperformance and corporate cost-cutting.
People are trying hard to forget the reputations of the prestigious accountants and the “best” investment banks. The fines against Wall Street and the investigations of Jack Grubman, Frank Quattrone, Martha Stewart et al. showed a belated attempt to rein in the corporate excesses. Should culprits try to destroy incriminating electronic evidence, then data recovery procedures will be able to retrieve much of the destroyed evidence. Email audit trails in forensic accounting procedures will find them out.
A star fund manager is no longer accorded the status, but earns it. Disappointing performance drops them into the satellite group of also-rans. The research done by actuaries, forensic accountants and other financial analysts offers sound ground for assessing staff selection. Background checks for finding real suitability, rather than professional skill listed in a glossy CV can find out the sad truth. Otherwise, risk and return appetites become more estranged.
Similarly, the reputation of a “top” services company can be just as short-lived and cheap as a bacon-lettuce-tomato sandwich. Go for performance delivered. Give them a check-list or interview to see if they can show results and sincerity.

VALUE FOR MONEY

admin — Mon, 19 Oct 2009 14:43:10 +0000

Shop around for the best service or risk-return offer. Get the most suitable value for money plus caution-danger calculus for you. Because an investment is a labour project, keep a proper log of time worked on your behalf and materials used by contractors. A bank or fund should use people like hiring a plumber. Employing a star trader without value for money or risk considerations is a recipe for disaster. The cross-reference table of staff selection based upon return (alpha), risk (sigma) and behavioural (theta) factors brings a more organic and profitable view of risk management.
Fund management has had to become more compliant with additional regulations. Funds are recognising the value of focusing on consistent return, not on reputation of individual staff deemed as “stars”. Alpha, the active return, is a better and consistent profit compared to the ephemeral advantage of trader’s luck, or fraud. This screening of investors and diversification of assets helps us to separate the real stars from the also-rans in the surrounding satellite performers.
Similarly, capital expenditure projects should be assessed for cost benefits rather than simply high profile. Most of the financial dealing systems we have worked on rely on a higher expenditure and publicity for the glamorous front-office dealing end. The drab back-office and accounts side was largely side-lined by comparison. This attitude can have a serious, unintended cost.
Had Barings purchased a system that enabled the settlements department in London to reconcile trades made in any part of the world with clients’ orders . . . . . . . . . Leeson’ s fraudulent of the 88888 account would have been exposed within months, if not weeks. Such a system, known as BRAINS, would have cost about £10 million.
The resulting fraud by Leeson was estimated at £800 million.

ORGANIC DUE DILIGENCE

admin — Sat, 10 Oct 2009 14:41:43 +0000

Everyone wants profit on their investment, but we all invest different amounts of resources in research. A modern bank or fund would be happy to invest $50 million into a venture and to spend $500 000 on a due diligence with lawyers. It would be unwilling to fork out $5000 on discreet enquiries and a chat with detectives in the FBI, Russian FSB, City of London Fraud Squad or similar. Due diligence has become ossified in its own rigorous blinkered thinking.
Fallacy: only banks, insurers, lawyers and accountants have the monopoly in professional investment knowledge.
Private investigators, from AON, Marsh, Control Risks Group, Pinkertons and Wackenhut all offer potential corporate added-value here. They also operate under the forensic accounting banner to undertake deep financial and behavioural analysis. A proper due diligence can win through more flexibility and discretion. One such due diligence by Dynegy on Enron made the correct call on risk hazard and called off the merger. It saved an unbelievable fortune.
Basel II enables Moodys and Standard & Poors, plus the corporations themselves, to certify the level of operational risk. Some groups will have become disposed towards offering a more tailored or sympathetic risk assessment. The traditional credit-rating visit cannot be so highly valued seeing that the target company has lots of advance warning. To paraphrase Heisenberg’s principle of uncertainty:
You can never be sure of the direction or health of a target company, because these are directly affected by the means you use to observe them.
Newer aspects of this investigative process show that company data are more accurate and accountable when the target is completely unaware of the observation carried out by snooping. Forensic accounting comes in useful; it is more akin to industrial espionage, but the data is less likely to be compromised by a public relations exercise. These forensic agents can be employed to separate performance from ill-deserved reputation. They can take the subtle, covert observation of the subject to get closer to the truth.
Then, they can get the metaphysical corporate handcuffs on the risk-offering crook. More flexible analytical activity clearly complements the bank’s own analysts and traditional due
diligence process. Forensic accounting comes in to provide a deeper investigation. Otherwise, banks and financial companies suffer when they are still locked in a narrow corporate group- think.

MATCH RISK TIME HORIZONS

admin — Sat, 03 Oct 2009 14:39:02 +0000

No professional football player wants to stick his neck out, or his health, for more than the designated 90 minutes. Some companies are already playing close to their limits in extra time. Investors’ risk time horizons should match the risk scenario.
The sophisticated investor is already aware of these potential cash-flow problems. What is rather more galling is when cash is running dangerously short, despite all prognostications. Companies play out favourable scenarios with dwindling assets or cash. The complication arises from the chain of market players all with different risk time horizons. Everyone wants a cut or return at different times. Because investors have different entry times and various time horizons, it is no longer fitting to state as gospel truth that all long-hold investment decisions are correct. The real risk curve will change along time and market conditions; this can be startling to learn.
It is also important to recognise that the available data and the criteria for judging acceptability may change with time so that what might have been acceptable when a project was initially proposed may no longer be so several years on . . . Thus, the acceptability of the risks associated with a project must be kept under constant review throughout the life of a project.
The real risk curve will differ from the expected risk curve; sometimes, even the most respected pension fund or venerated CEO will fail hugely. An eternal buy-and-hold strategy may no longer be suitable in the modern market. Reputation risk management means that we have to separate deserved prestige from the veneer of respectability and corporate performance. CEO worship is no longer worth the votive candles burnt. The truth may be more along the lines of a real risk curve laid out for the sake of discussion. Unfortunately, the time horizon of a CEO is usually in months and not years – this creates the need to maximise the most that can be wrung out of the firm. Thus, balance sheets can be cosmetically made up for a smoke-screen, not for the benefit of investors.

MATCH RISK APPETITES

admin — Sat, 26 Sep 2009 14:37:31 +0000

The media headlines tend to focus upon the wrong targets. These focus upon criminal managers’ activity, or rogue traders. But, most company underperformance or losses are the result of those innocent errors – operational risk and strategic risk. That means that a single top-level planning fault, or a dozen daily back-office errors, will often add up to much more damage than a single rogue trade or fraudulent activity.
We need to re-assess our risk-return appetite against the likely returns in the quagmire of mixed competencies and unrealistic expectations. Risk appetite must match the risk offer. The investor must meet the company, in person or by telecommunications, and grill it with questions: “Is the CEO innocent but incompetent; or much worse?” “What was his previous record?” “How can I get past the PR to track him down?”
One of the potential hazards is that CEOs and CFOs are advertising the value of one asset – their innate management skill. This only enrichens their bonus pay, pension and stock options.6 Where the investor is faced with an unfamiliar company executive or a novel asset, then a risk management methodology such as RAMP may offer much benefit. A risk review by unbiased parties using forensic investigative techniques can provide a lot of benefit. A risk- mapping analysis by impartial experts can be obtained in a Delphi-group risk-reward analytical process.

IDENTIFY STAKEHOLDERS AND INTERESTS

admin — Sat, 19 Sep 2009 14:37:20 +0000

Operational risk involves the actions of many business groups, so mapping out the investors and stakeholders is an organic process and a complex one. PRINCE 2 and RAMP are examples of two methodologies that place stakeholders and expected returns on paper. We can deploy risk analytical tools. We can consider poor company performance or financial loss as a hazard requiring detailed risk analysis. The causal element or risk catalyst stems from unsuitable leaders or inadequate investment managers leading to a fall in earnings and damage to business reputation. The dreaded result is the risk event, such as the adverse effect of a start-up investment loss or disastrous M&A decision. Analyse the subjective worth of the company heads – determine the value-added (positive or negative) that can be ascribed to the top management. One effective method is to interview then face to face to find the truth.2 Already, regulators are expanding and are on the war path gearing up for getting tough on criminal activity by corporate management.
The UK’s chief financial regulator is lobbying the government for the same powers as its US counterpart to stamp out accounting abuses by companies and guard against Enron-style business scandals. . . . . It would amount to the biggest shake-up of corporate accounts policing since scandals such as Maxwell and Polly Peck. Under the plan, the FSA would resemble the Securities and Exchange Commission . . .
The widening definition of crime, e.g. to include false accounts and money-laundering, mean that command-control must be established within an organisation. Some of these can be monitored automatically using computer software with AI logic. Companies that provide a rosy interpretation of balance sheets for the public need a more thorough grilling by the auditors, who are now more alert to their duty. The investors and auditors are on the offensive against fraud. The corporate barriers against truthful information for investors are being attacked, led by funds, shareholder advocacy groups and regulatory authorities.