Interview With Susan Mangiero, PhD About Fraud Prevention

As a forensic economist, I have worked on multiple matters relating to the quality of fiduciary practices provided by investment stewards. Sometimes, fraud is involved. Unfortunately, the statistics about fraud are not good. According to the 2014 Report to the Nations, published by the Association of Certified Fraud Examiners ("ACFE"), "the typical organization loses 5% of revenues each year to fraud" or about $3.7 trillion - roughly "22 days worth of trading on the New York Stock Exchange."

Last fall, I pursued and earned the designation of Certified Fraud Examiner. I had to meet an experiential requirement and successfully complete a series of rigorous exams. Click to read the press release and learn about the designation.

A few weeks ago, to my delight, I was asked for an interview by the ACFE. The result is a just-published Question and Answer profile entitled "Susan Mangiero: Take Pride in Curiosity." During the interview, I talked about trust and the value of maintaining a good reputation. Specifically, I described a situation that involved a trader who had backtracked on several deals. After news got out, few persons understandably wanted to deal with him.

Having a good reputation in business, especially financial services, is still important. In recent years, I have been asked to quantify the economic relationship between reputation and the ability for a firm to generate revenue based on the trust factor. Feeling comfortable with an advisor, consultant, banker or asset manager is paramount for an institutional investor who is obliged to carefully select and monitor a third party service provider.

Coincidentally, the CFA Institute just released its study entitled "From Trust to Loyalty: A Global Survey of What Investors Want." In its "Key Insights" section, the point is made that performance and ethical conduct are both important, with investment managers needing to demonstrate that they have gone beyond "adherence to mandatory codes of conduct." This makes sense. Governance is seldom a "check off the box" exercise. (As an aside, I am proud to say that I am a CFA® charterholder."

With the investment community abuzz about the U.S. Department of Labor's proposed Conflict of Interest Rule and its international regulatory equivalents, transparency, ethics and performance issues will no doubt remain high priorities for investors.

Key Person Risk - Whom to Back

On March 1, 2010, Dr. Susan Mangiero, CEO of Investment Governance, Inc. sat down to talk to financial and strategy expert, Mr. Pascal Levensohn. In this third question of ten, read what this Investment Governance, Inc. Advisory Board member has to say about key person risk. Click here to read Mr. Levensohn's impressive bio.

SUSAN: Given recent instances of VC-backed company fraud and questions about the management team, how can institutional investors protect themselves from key person risk?

PASCAL: You are asking a fundamental question here about trust. I could restate your question by saying, how do I know that I’ve backed someone as a general partner ("GP") who is trustworthy?  The answer is, you have to do your homework on that person, which means that you have to make a full range of reference calls to people who are not on the person’s reference list.  This takes resources and time.  If you are not equipped with the resources to do the work, then you need to rely on someone else’s process—but again that has to be an independent third party whose due diligence credentials are also trustworthy.

Let me turn the table on you a little bit because I sit in your shoes all the time– as a venture capitalist who bets on entrepreneurs, my greatest challenge is to sit across the table from a very enthusiastic person and judge their credibility—Will they actually do what they say they are going to do?  Will they work 24/7 to get the job done?  How will they behave when unforeseen challenges occur—which they always do? 

Institutional investors have to do the same thing because they are betting on people, and they need to establish a considerable measure of trust if they are going to sign on to a 10 year commitment to invest in illiquid assets.  This is the toughest part of our jobs. As I look back over my the 14 years I have spent in venture capital, as part of my 29 year finance career, the biggest mistakes I have made have always been related to key person risk, as opposed to picking the “wrong” technology.

Trust, Institutional Investors and Their Service Providers

 

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.