Home / Royal Commission throws up due diligence questions

by Alex Wise*

Decision making by Australian trustees and fiduciaries has been called into question during the recent hearings at the Royal Commission into banking and super. Effective due diligence underpins informed decision making when appointing external fund managers, argues Castle Hall.

In today’s world of ever-widening duties on those charged with investment decisions, the question arises how well do you really know this fund manager?

Trustees, board members and C-level executives responsible for manager selection have likely all imagined themselves before the Royal Commission, contemplating what it would feel like to be on the receiving end of a stream of tough questions. No-one wants to be in the position of not having all the answers when the gavel brings the next Commission into session.

When first hiring a fund manager, evident business problems, weaknesses and conflicts cannot be ignored. The Royal Commission makes it abundantly clear that this fundamental rule applies, however tempting the performance might be, or however appealing the fees which can be generated.

Second, the hardest questions will always arise with the benefit of hindsight when (not if) things go askew. What are your views on the manager’s recent charges for bribery and corruption? What do you think about their recent cyber breach? What made you allocate to this manager when it has such apparent conflicts of interest?

A thorough, independent and private operational due diligence (ODD) review enables an in-depth understanding of the business and legal risk of entering a relationship with a fund manager. This understanding, when documented and approved, empowers trustees to stand behind their decisions, demonstrating that decisions are only taken after appropriate due diligence has been completed. Fiduciaries should always be able to point to a robust process that has been consistently applied in order to negate pointed questioning on why a decision has been made.

Due diligence should also actively monitor the investor’s “supply chain” – their roster of vendors (fund managers selling investment services). It is clearly best practice and a direct regulatory expectation to conduct an effective ongoing diligence monitoring program.

Similar to any supply chain risk management program, ongoing ODD for supers funds should consider, at a minimum:

• What’s in the public domain (if I Googled the manager, would I find new information that I’m not currently aware of? Do I know that the manager’s US affiliate has just been fined in a sexual harassment case?)
• What has the vendor sent us (have I read all communications from the manager? Do I know what’s hidden on page 5 of last quarter’s manager report? Have I reviewed the recent financial statements for adverse disclosures and discussion of new risks?)
• What ongoing information do we request from each fund manager on an ongoing basis? Do we regularly ask our managers to report information on, for example, staff turnover, new products, regulatory inspections, or claims and lawsuits? And,
• How can information be disseminated across the team and then stored to retain an evidenced and auditable trail of ongoing due diligence? Effective ongoing monitoring requires a robust ‘regtech’ solution, not emails and spreadsheets.

For super funds exhibiting strong practice, these monitoring processes are enshrined in a due diligence policy. An effective diligence policy document will have been carefully crafted and undergone board review and approval to ensure an alignment with the cultural expectations of the board on behalf of the member base.

Perhaps the first rule of due diligence is very simple: “don’t be surprised”. Appropriate due diligence provides a strong defence to fiduciaries (or at least those that have undertaken it properly). When, as opposed to if, things go wrong difficult questions will be asked.

*Alex Wise is head of Australia and New Zealand for Castle Hall, a global due diligence expert.