Pension Risk Matters : Pension Risk News & Analysis : Investment Governance, Inc. : Pension Risk & Investment

A recent news article about a hedge fund divorce is a good reminder that pensions, endowments and foundations can be adversely impacted by personal break-ups. (See "Ikos Divorce Rattles Firm; Cash Exits, Staff Gets Ax" by Cassell Bryan-Low, Wall Street Journal, July 26, 2010). Many hedge funds take the form of partnerships or private member entities such as an LLC. When ownership is concentrated in the hands of a few individuals, key person risk merits review, along with a need to ask tough questions about whether and what type of succession plan exists should a prominent player depart from the organization. When marital splits occur and the spouse cum business owner's wealth is concentrated in the equity of the hedge fund enterprise, a judge may force a liquidation to pay alimony. All of a sudden, buy side clients could find themselves with allocations in the hands of new managers, including perhaps the aggrieved husband or wife who now owns his or her "fair" share, post marital bliss.

While somewhat impolitic to inquire about one's hubby, wife or significant other as part of a hedge fund due diligence meeting, an institutional investor is certainly within its rights to ask about how the ownership of the fund as a business might change with a marital dissolution or a disagreement among partners or both. The issue is significant enough that some hedge funds have asked key employees to sign a post-nuptial agreement with the Mr. or Mrs as a way to protect company assets.

Ain't it romantic?

Editor's Notes:

• When I was an appraiser and valued business interests such as ownership in a hedge fund, I co-authored "Complex Compensation Issues in a Divorce" (Forensic Accounting in Matrimonial Divorce, Journal of Forensic Accounting, 2005) with divorce financial planner, Ms. Lili Vasileff .
• One of the few articles I've read about hedge fund succession planning is entitled "Planning for Hedge Fund Manager's Success" (Institutional Investor's Alpha, April 2004) by prominent investment attorney Stephanie Breslow.

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The plight of the hamster is simple. He is cute, furry and going nowhere fast. Sure he gets exercise but, measured in inches and miles, he's stuck in the same place, treading the same pattern over and over again.

Lest this sound like a zany rant from a busy blogger, might I suggest that the current spate of "pay to play" scandals reflects what some in the industry have been saying for years? Be scared, be very scared about the dsyfunction that is roiling financial markets. 

With respect to writer George Santayana, "Those who cannot learn from history are doomed to repeat it." With Enron, Worldcom and Bear Stearns far from a distant memory, why on earth are we still reading about bad players who end up costing taxpayers, shareholders and innocent bystanders gazillions of dollars? Worse yet, those individuals who wear the fiduciary hat proudly are being unfairly tainted by those who should know better and/or simply do not care about the lives they ruin with their bad acts.

Recent articles about California and New York pension problems only add fuel to the fire and leave most folks scratching their heads, asking legitimate questions, some of which are listed below:

• Given existing regulations, why are there so many scandals?
• Where is the board oversight that is supposed to prevent conflicts of interest or at least nip things in the bud before losses mount?
• How much are Sally and Joe "everyperson" supposed to tolerate in terms of broken trust on the part of those tasked with leadership?
• Why aren't major lessons being learned sooner than later?

As an ardent advocate of capitalism (and no, we do not have a pure capitalistic system in place anywhere, contrary to Michael Moore's movie lament), I find the current state of affairs impossible to defend.

Bad practices have got to stop. We need to be moving forward, not running around and around, making no progress and chasing our tails. Let me also add that I am not objective here. Our company (newly named Investment Governance, Inc.) has been busy at work for nearly a year, building investment "best practice" tools (to debut in short order). What has kept our team going lo these many months of 15 hour days are the repeated and strident cheers from all the good guys and gals who take their institutional fiduciary work seriously and want things to improve in a big way.

Bravo to those for whom trust is a sacred word! We seek to help you gain the recognition and support you so richly deserve. 

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Financial scandals, decimated 401(k) plans and significant fallout on Wall Street are only a few of the pain points that leave one longing for halcyon days of yore. There is a lot of talk about broken promises and attempts to regain client trust.

Even outside the financial services sector, long known for its reliance on interpersonal relationships, sellers are working hard to rekindle the love with their consumers. In "Corporations work to regain customers' trust" (September 18, 2009), Business Week reporters David Kiley and Burt Helm write that "In the world of branding, trust is the most perishable of assets." Adding to marketers' woes, recent polls suggest gross unhappiness with business in general, something that slick ads are unlikely to fix.

Closer to home, "Can You Trust Your Consultants and Service Providers? (Human Resources, October 2009) addresses the critical relationship between service providers and consultants and 401(k) plan fiduciaries. The article quotes Nixon Peabody attorney Sherwin Kaplan as saying that "trust with providers should be earned, not implied" and that sponsors must properly select and then monitor each vendor. Aside from the obvious problems associated with conflicts of interest and fees, Attorney Kaplan mentions new worries in the form of fiduciaries suing each other over questions about suitability and due diligence.

In yet another related item, uber venture capitalist Fred Wilson opines on "Ten Characteristics of Great Companies" (September 3, 2009) with attribute number 10 being that "Great companies put the customer/user first above any other priority." We concur absolutely but know that more than a few service providers are challenged to deliver above and beyond the call of the duty at the same time that sales and client relationship management budgets are being cut to (in some cases) unsustainable levels. 

In "Broker's World: Fiduciary-Like Process Could Become Voluntary" (September 23, 2009), Wall Street Journal reporter Annie Gasparro describes the inevitability of a national (U.S.) focus on new broker-dealer rules. Boston University law professor Tamar Frankel is quoted as saying that "If the clients can trust them, they won't have to do all the freebies like lunches to get their business."

As both a buyer and seller of services, I like to think that my perspective considers both sides of the aisle. In the spirit of open conversation, I've listed a few thoughts below. I welcome your comments.

• Integrity (a precursor to building a relationship of trust) must be a core element of an organization's enterprise-wide culture.
• Customer service does not have to deteriorate with budget cutbacks.
• Discounting of fees does not necessarily translate into automatic trust, especially if it encourages a service provider to cut back on quality or lose money instead.
• Clients should be willing to provide constructive feedback to service providers before calling it quits. A reasonable period of "remedy" should be decided upon before pulling the plug.
• The compensation structure on both the buy and sell side should encourage long-term value maximization on behalf of relevant constituencies.
• Conducting assessments as to what remains critically important to institutional investors versus "nice to have" or "waste of time" should occur on a regular basis.

It is undeniably a brave new world. Without trust and a focus on long-term relationship building, new business for investment service providers may end up costing a bundle. Instead of being hired to "rescue" institutional investors such as pensions, endowments and foundations by granting advice, an absence of trust could induce more risk in the form of litigation and harm to reputation, resulting in service providers themselves asking for a safety net.

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