Murky world when you delve into due diligence


Chris Addy, Montreal-based founder and chief executive of the world’s largest specialist due diligence firm, Castle Hall, is an entertaining speaker. Sadly, most of his entertaining stories are about financial disasters which investors could have avoided.

Addressing the Fund Summit conference in Melbourne last week (see separate reports this edition), Addy said that good investment governance and due diligence were about “minimising the risk of surprise”. He believes that in the evolution of due diligence, generally, the process has entered a new phase, which he calls ‘Due Diligence 3.0’.

Before the Madoff scandal, it was ‘Due Diligence 2.0’. Prior to that the sorts of background checks done on managers by big funds or their consultants tended to be perfunctory. It was a “cottage industry” Addy said. “But with Due Diligence 3.0, the industry is being institutionalised and is expanding across all asset classes and involves active ongoing monitoring.” Castle Hall has about 90 employees in six office around the world, including Sydney where local head, Alex Wise, resides.

Addy is not afraid to talk about specific cases, such as the ongoing saga regarding Ken Fisher, a very successful US traditional long-only manager, which Addy puts in the ‘sexual misconduct’ category. It was what Fisher said, rather than what he did, that did the damage to his firm, Fisher Investments. The Michigan Investment board reacted first to his sexist comments, withdrawing its US$600 million mandate. So far, five other institutional investors have followed, putting total withdrawals to date at more than US$2 billion. The recent total, as of last week, with other drawdowns, is more than US$3 billion lost.

Addy recounted that Fisher used inappropriate language at an industry conference in the US on October 8. But he had had a reputation for doing so. What he said publicly last month was that winning new clients was like picking up women at a bar. Apparently, he made similar comments at a conference in 2018.

“It’s difficult to be aware of that sort of reputational risk before it happens,” Addy said. “But you start with information that’s in the public domain, such as the media and SEC filings. And, we need to make sure that we have read what the manager has sent to us.” For instance, manager reports often go straight to the front office, where people are interested in daily portfolio changes.

They may not notice, say, that at the bottom of page three in a manager’s letter, it is noted that a compliance officer has left the firm for ‘personal reasons’. This might be followed by the departure of the chief risk officer, Addy said.

In the private equity space, a recent example concerned a Dubai-based firm called Abraaj. It has been alleged that money was stolen to cover client shortfalls. The auditors missed the discrepancies until it was too late. “If you were the CEO of KPMG in Dubai, where would your son work?” Addy asked. “Abraaj, of course”. After the fraud was discovered the firm was fined a Dubai record of US$315 million and has subsequently collapsed.

– G.B.