University Business - March 2011 - (Page 32)

Universities and Investment Fraud Because endowments have many money managers competing for their business, he says they should be willing to move on to the next candidate if they sense that something isn’t quite right. “There’s nothing wrong with saying no.” Four Questions for Due Diligence Securities lawyer Gianluca Morello advises that officials ask these questions before an institution’s money is invested in a particular fund: 1. Is there an independent custodian for the money? Investment funds should keep investor money on account at a brokerage firm or a bank trust department. 2. Is the fund audited? “Just about every reputable hedge fund has an independent auditor,” Morello says. Small funds sometimes don’t hire an outside accounting firm, citing cost, but that is too much risk for a fiduciary to take. Bronté Jones of St. John’s College (Md.) agrees, saying that finding out who handles a fund’s audit is a key step in their investment investigations. 3. Do fund documents appear to be professional? Appearances matter, and a legitimate business will present professional, proofread documents. Although one might think that even a crook could use a spellchecker, Morello notes, “I’ve seen offering documents from hedge funds that turned out to be Ponzi schemes that had all sorts of silly spelling errors.” 4. Have references been checked? Morello suggests that fiduciaries always do this. Even though a fund is likely to give only good references, a prospective investor can check out the relationships of those references and find others outside of the fund who can give some perspective. “It’s another piece of the puzzle.” These measures involve a lot of work, but the hard part is to act on the information uncovered. Morello says that, in many cases, people see problems in due diligence but choose to overlook them. “The Ponzi schemes I’ve seen had tons of red flags.” The Human Aspects “You have to maintain a healthy sense of skepticism,” Alt says, and that’s very much key to avoiding frauds. But that’s not always easy. Huddleston notes that many problems start out with conflicts of interest involving board members. “If we’re nominating our buddies, we can’t be objective and say that we’ve chosen the right guy.” One has to be made aware of his or her own biases before acting on them, and training may help. Huddleston recommends investment committees discuss manager integrity at every meeting. A money manager going through a divorce may be tempted to behave wrongly because of personal stress and financial pressures, he notes as an example. “You aren’t a bad person, or evil, or hopelessly cynical to do this analysis.” At St. John’s, Jones and staff have identified board members in the best position to meet with money managers, and they send them out to talk face-to-face. Then, everyone meets quarterly to document who attended which meeting, to create an internal paper trail. The work has to be ongoing, Huddleston says, because few financial scammers start out crooked. Many, he says, start out legitimate, and then fudge numbers to avoid posting disappointing results. The money manager hopes to make it up in the future, but that never quite happens; once someone crosses the line, it’s hard to come back. “We’re talking about human beings and human reactions,” he says. of the authorities.” Then, investors should ask for their money back, but they should not try to negotiate with the suspected firm, as that can cause more trouble. Investors often want to negotiate instead of report, too. If a fraud has occurred, the regulators have the right to order any investors that took a payout of profits to return them—a process known as claw-back— something that investors want to avoid. After all, it’s bad enough to lose money on Resources Financial Industry Regulatory Authority, www.finra.org Hall Capital Partners, www.hallcapital.com Investment Fiduciary Leadership Council, www.iflcouncil.org Investor’s Watchdog, www.investorswatchdog.com National Futures Association, www.nfa.futures.org Roland|Criss, www.rolandcriss.com Uniform Prudent Management of Institutional Funds Act, www.upmifa.org Wiand Guerra King, www.wiandlaw.com Addressing Suspected Problems Frauds are rare, but they happen. What happens if a college executive reaches the sickening conclusion that the campus is involved in one? Report it to the Securities and Exchange Commission immediately, Morello says. “You’ve got to bring it to the attention 32 | March 2011 account, it’s even worse to lose funds that were spent years ago. Morello says that a claw-back is an unfortunate reality—and a very bad reason not to file a report. There’s a new silver lining to filing a complaint, Huddleston says, that could lessen or even offset the effects of a claw-back. Endowments may be able to file claims under the whistleblower provisions of the DoddFrank Wall Street reform act, which became law in 2010. These allow anyone providing original information about violations of securities and commodities laws to receive up to 30 percent of any sanctions that exceed $1 million. “I’m really excited about that,” Huddleston says. It’s good to know, because this story won’t go away. Frauds are as old as human nature; careful fiduciary behavior can reduce the risk and limit the damage, but it can’t prevent every scam lurking in the investment business. “The next Madoff is in the making right now,” says Hagan. Ann C. Logue is a Chicago-based freelance writer whose former career was in financial analysis. universitybusiness.com http://www.finra.org http://www.hallcapital.com http://www.iflcouncil.org http://www.investorswatchdog.com http://www.nfa.futures.org http://www.rolandcriss.com http://www.upmifa.org http://www.wiandlaw.com http://www.universitybusiness.com

Table of Contents for the Digital Edition of University Business - March 2011

University Business - March 2011
Contents
Editor’s Note
College Index
Company Index
Advisory Board
Behind the News
Sense of Place
Viewpoint
Human Resources
Universities and Investment Fraud
Going the Distance
Meeting the Transparent Pricing Mandate
Community Colleges
What’s New
End Note

University Business - March 2011