I know it when I see it. That’s what people say when they can’t describe what they instinctively see, or otherwise understand.
Back in the day, while I was still performing due diligence reviews as part of my job, I found that a lot of people in the industry thought that there was a magic formula for evaluating a subadvisor or fund. It was viewed as a bit of a secret, that perhaps nobody else knew. And yet, my work was actually more of a scientific exercise in performing basic research, mixed with the art of “knowing it when I see it.”
The following are 7 tips for your firm’s next due diligence review.
1) Collect materials (ADV, DDQ from firm, Prop. Questionnaire, etc): Evaluate regulatory landscape, client/exposure/product, the Manager's general risks.
2) Understand the overall business and where it operates: A due diligence officer’s first task is to get to know a company and understand its business. Is it a big firm with robust processes and resources, or a small shop with a shoestring budget? Does the firm deal with easily traded/settled securities, or are they trading term loans, derivative contracts, reinsurance, physical real estate, and/or private equity?
3) Track the flow of money into and out of the firm – from investment to redemption: What are the inherent risks and how are they mitigated? Once a due diligence officer knows how a firm does business, the next step is to review the trading process from beginning to end.
4) Talk to the traders: We know what they trade; now we need to know how they trade. What’s their approach to opening and closing positions? What technology do they use and how do they use it? How do they measure trading performance?
5) Talk with Operations: How are trades captured and communicated to Ops? How do they confirm and settle? Evaluate the reconciliation process — what happens with fails? How are business continuity challenges handled? Review real examples.
6) Talk to compliance and risk management about their overall program: Include past exams and the results, current annual assessment, and prior year over year changes. Be sure to assess how the compliance and risk program fits their business and the regulatory environment they operate in. Do they have the right level of resources?
7) What is the IT infrastructure like: Evaluate the disaster recovery protocols. And business continuity. What steps are being taken to ensure cyber security and the safety of confidential data? Smaller firms used to be able to hide, but now everyone’s a target.
Onsite meetings are a critical part of a due diligence review and one where many clues to possible problems are discovered. If you've been in a lot of offices, you know what the business should look like and how it should be organized. You can recognize when something isn't right. For example:
- Is the compliance team located in a basement closet?
- Does Operations look like a sea of paper?
- Do people seem stressed?
- Can they articulate what they actually do vs. what the due diligence questionnaire says?
With experience, you know a firm that passes a review from one that doesn't. Take it from a former due diligence officer; you’ll know it when you see it.
IMP can provide your firm with help completing an operational or compliance process review. Furthermore, we offer solutions that ensure transparency, accountability, and adhesion to firm protocols regarding trading and compliance processes while also making sure your firm gets the most out of its technology solutions. Click here to learn more about our CLEAR compliance tools or ask a specialist for more information.