After the recent Bloomberg study of the world's largest hedge funds (see post), Institutional Investor has equally published their annual list of the supertankers of the industry. The 2011 list is available here.
A new study from Bloomberg lists the current Top 20 hedge funds in terms of size. The price of entry? $17 billion in AUM.
Rank FIRM/LOCATION AUM
1 Man Group / London 69.0
2 Bridgewater Associates / Westport, CT 62.0
3 JPMorgan Asset Management / New York 45.5
4 Paulson & Co. / New York 36.0
5 Brevan Howard Asset Management / London 32.3
6 Och-Ziff Capital Management / New York 28.7
7 Soros Fund Management / New York 27.0
8 BlackRock / New York 26.6
9 Highbridge Capital Management / New York 25.0
10 BlueCrest Capital Management / London 24.5
11 Baupost Group / Boston 24.0
11 Cerberus Capital Management / New York 24.0
13 Angelo Gordon & Co. / New York 23.5
14 Farallon Capital Management / San Francisco 21.5
15 Winton Capital Management / London 20.0
16 King Street Capital Management / New York 19.9
17 Goldman Sachs Asset Management / New York 19.8
18 Canyon Partners / Los Angeles 19.0
19 Renaissance Technologies / East Setauket, NY 17.1
19 Elliott Management / New York 17.1
In mid 2008 we commented on the London branch of the Toronto Dominion bank in London, where a "senior male trader" had "incorrectly priced credit derivatives" resulting in a loss of nearly $100 million. At the time, we emphasized the lesson that this mispricing was not the work of a junior, green employee, but the senior head of a bank's trading desk.
The wheels of justice can move slowly, but an industry friend (to whom we express our thanks) forwarded some updated information. The FSA have just published a final notice on the case:
This notice is issued to Nabeel Naqui as a result of his conduct during the period July 2006 to June 2008 (the "Relevant Period"), during which he was employed by Toronto Dominion as Head of the Credit Products Group (“CPG”), Europe and Asia Pacific desk. During this period, Mr Naqui deliberately:
(1) mismarked his trading book; and
(2) subverted the independent process by which Toronto Dominion checked the valuation of its trading positions at the end of each month. Mr Naqui altered prices he had obtained from independent dealers to correspond to the prices at which he had marked positions in his book. Mr Naqui then provided these altered price runs to those responsible for conducting the independent valuation process, knowing that they would be used as the basis of their valuation.
As our industry friend noted, the first question is obvious: exactly how can pricing runs provided by the trader be helpful for those "conducting the independent valuation process"?
The FSA, helpfully, gives some more information:
"The CPG [Credit Products Group] Europe and Asia Pacific desk was run from London and headed by Nabeel Naqui, a Managing Director. As well as being Head of Desk and responsible for other traders, Mr Naqui was also responsible for trading credit default index and tranche products (“the Products”)....
All CPG trading positions were subject to a month end Independent Price Verification (“IPV”) process in Toronto Dominion during the Relevant Period. The IPV process required the Global Middle Office (“GMO”) to revalue all positions held by the firm’s traders at month end on the basis of independently sourced market price information. The objective of the IPV process was to reveal any error or bias in pricing so that this could be corrected and inaccurate marks eliminated.
OK, fair enough. But let's learn a little more about the "revaluation" conducted based on "independently sourced market price information":
Mr Naqui was aware that in order to conduct the IPV, GMO used series of market price quotes, known as runs, which he provided to them every month, rather than sourcing these independently from dealers. Mr Naqui was regularly asked by GMO to provide particular runs for use in the IPV process. Mr Naqui obtained runs in electronic messages from independent dealers, and then forwarded them to the relevant individual within GMO.
Yep - the trader was the one who gave the back office the "independent" broker runs. And guess what happened next...
Before Mr Naqui sent the runs on to GMO, however, he altered particular prices within the runs to correspond to the prices at which he had mismarked his front office positions. He did not alter all prices in which he held positions on his trading book. Mr Naqui did not mark or highlight the altered figures, or provide any indication within the message that some of the figures it contained were not figures supplied by the independent dealer. As a result of this method of circumvention Mr Naqui’s mismarking remained undetected for a period of approximately two years, until after he was informed that Toronto Dominion proposed to make him redundant.
Well, predictable stuff so far (and sound like any administrators we know?) We do, however, like Mr. Naqui's response:
Mr Naqui asserted that he had amended the quotes for a number of valid reasons. Mr Naqui claimed that one of the principal reasons why he had been obliged to amend the forwarded quotes was so that he was able to negate the impact of what he characterised as systems issues. Mr Naqui explained that there were flaws within the systems used by Toronto Dominion and that these resulted in inaccurate valuations. Mr Naqui relied on evidence which tended to show that he had raised these issues with others within the bank; however Mr Naqui complained that he had not received a satisfactory response to the document he had drafted. Mr Naqui claimed that thereafter he had only ever escalated his concerns about the systems difficulties during the course of face to face meetings with his immediate superior. Mr Naqui accepted that there was no record of any of these attempts to complain about the systems issues, though he did complain that his immediate superior was not a credible witness. Therefore and notwithstanding his reservations about the systems Mr Naqui had been obliged to forward quotes to GMO and thus he had decided to amend certain quotes.
The conclusion of the FSA:
It is clear from the foregoing that the FSA finds that ‘systems issues’ do not excuse or explain Mr Naqui’s conduct. The FSA does not accept the criticisms made by Mr Naqui of both the reports produced for Toronto Dominion. In particular the FSA finds that the recent expert report rebuts Mr Naqui’s contention that he was obliged to amend particular quotes to negate the effects of systemic problems. The FSA finds that Mr Naqui selectively amended quotes only where it was necessary to disguise losses in his book. The FSA finds that were Mr Naqui to have been seeking to cater for systemic issues then it would have been more appropriate for Mr Naqui to have amended all of the quotes that he forwarded to GMO. The FSA finds that whilst there may have been some problems within the systems these did not excuse his decision to amend quotes and nor did they explain the extent of the losses created by his mismarking. The FSA also rejects Mr Naqui’s claim that, having attempted to highlight the systems issues to senior management through a paper on the topic, he then only ever escalated this to his immediate superior in the course of face to face discussions.
One of favorite maxims is this: we have yet to meet a trader who is not supremely confident that his marks are correct, especially when he or she knows that they are wrong...
And on a lighter note, we were amused by an article in the UK's Daily Mail discussing a blog written by "Austerity Mum". In today's economic climate, the author - Lisa Unwin - has been documenting her family's efforts to tighten their belts, including (wait for it) fewer helicopter rides, no family vacation in the Maldives and even (gasp!) the decision to resole her husband's Berluti shoes rather than simply buy a new pair.
What is a little more surprising is the source of the family's wealth - Lisa's husband, Ashley, is the head of PricewaterhouseCoopers' consulting practice serving the City of London, which we assume includes hedge funds. It is interesting to see just how lucrative the Big 4's consulting services can apparently be - certainly more lucrative than the mundane audit process. And yet, for investors, which is more important - consulting to the manager or completing a vigilant and professionally skeptical GAAP audit?
A couple of years ago, Castle Hall commented on finance industry compensation as compared to other disciplines which also attract top tier intellectual and personal talent. In case of interest, one of the members of our team noticed a very thorough article in Bloomberg on the same topic.
The excellent Hedge Fund Law Report recently reported on the case of Joseph Sullivan, who was fired as COO and Chief Compliance Officer of the hedge fund Peconic Partners LLC back in 2008. According to a Bloomberg article at the time:
"The former compliance officer of Peconic Partners LLC accused the hedge-fund firm's owner of trading his own shares in a company ahead of clients' holdings in violation of securities laws.
Joseph W. Sullivan, who said he was fired Oct. 10  for objecting to the trades, made the claims in a lawsuit filed in New York state court in Manhattan against the principal, William F. Harnisch, as well as New York-based Peconic Partners and Peconic Asset Managers LLC...
Harnisch on Sept. 29 sold his entire personal holdings ofPotash Corp. of Saskatchewan Inc., about 600,000 shares, for an average $130 each, according to the complaint. Three days later, he sold about 1 million Potash shares held by Peconic clients for about $90 each, Sullivan claimed. Potash, the world's largest producer of the crop nutrient, had 301.9 million shares outstanding as of Oct. 31."
Bloomberg has more details as to the alleged activities:
"Sullivan, who also was chief operating officer, said his compliance software stopped working shortly before the Potash trades, and he never found out why. After the trades, his office computers became disabled in ``an apparent attempt to avoid his detection,'' of the trades, according to the complaint."
The particular twist to all of this: as with virtually all US hedge fund professionals, Mr. Sullivan was employed "at will". This US legal concept allows the employer to fire the employee (or equally for the employee to resign) with no notice and with no need to demonstrate cause or, indeed, give any reason at all.
According to the Hedge Fund Law Report (and another article in HedgeWorld), while Mr. Sullivan won his initial litigation for unfair dismissal, an appeals court has recently overturned that decision. The appeals court has apparently ruled that, irrespective of the circumstances, there can be no exceptions to the principle of at will employment. In other words, if you are a compliance professional and you do find that your boss has apparently been engaged in doubtful behaviour; or worse you find behaviour which definitely does violate internal compliance policies; or even worse the PM's behaviour is plain illegal....if you challenge him or her, the first thing that can easily happen is that you will get fired. Moreover you will have - it would appear - absolutely no recourse as an employee in relation to your own employment status.
Of course, the concept of "at will" employment is quite bizarre to anyone outside the US. Other countries generally do have a defined body of law protecting employees from unfair dismissal, which would obviously provide much more protection for whistle blower employees.
Within the US, however, this case certainly raises a significant red flag. As we all know, most hedge funds are small organizations dominated by the founding principal: it goes without saying that everyone else's job (especially everyone in the back office and compliance groups) depends on staying in the good graces of the king. We wonder how many compliance professionals will think twice about looking under the PM's stone if asking the tough question could mean losing your livelihood.
The NY Attorney General, Andrew Cuomo, has just filed a damning lawsuit (available here) against Ernst & Young, the auditor of Lehman Brothers in its run up to failure. The lawsuit focuses on various alleged accounting and audit failures, most notably the use of the notorious "repo 105" transaction which, with hindsight, sounds like a good ol' fashioned piece of accounting window dressing.
“This practice was a house-of-cards business model designed to hide billions in liabilities in the years before Lehman collapsed,” said Attorney General Cuomo. “Just as troubling, a global accounting firm, tasked with auditing Lehman’s financial statements, helped hide this crucial information from the investing public. Our lawsuit seeks to recover the fees collected by Ernst & Young while it was supposed to be using accountable, honest measures to protect the public.”
Ouch. Articles in both Bloomberg and Forbes have commented on this lawsuit, with neither exactly favorable to the accountants.
Looking at this situation, a number of thoughts come to mind. One is self evident: common sense would imply that it is simply not possible to be truly independent when a client pays $100 million in audit fees for the period 2001 to 2008. Such a fee level simply precludes any aggressively inquisitive effort to disprove management's number's and accounting presentation.
We particularly like the closing comments from the Forbes article:
"Audit firms need to be disbanded and downsized. Auditors can’t be paid by management and report to boards. We need a public trust and new system of audit engagement.
Accounting should not be a game of trickery and deception; it should consist of good old-fashioned honesty and accurate reporting. We need more bean counters and fewer accountant tricksters acting like investment bankers and financial engineers."