The Great Unspoken Danger

Yesterday, the U.S. House Committee on Financial Services conducted a preliminary hearing into the investigation of regulatory failure associated with the $50 billion Madoff Hedge Fund fraud.  Among those testifying was Leon M. Metzger, a Yale University professor and expert on hedge fund management.  His commentary included the following:

I wish to stress two things: first, the need for top-notch internal controls and second, that operational risk is the great unspoken danger.   A 2003 study of 100 hedge fund failures over a 20 year period concluded that 50 percent of hedge funds had failed due to operational risk...  When I was interviewed in August 2004 about teaching a hedge funds course at the Yale School of Management, I said that I wanted to emphasize good operational controls, which investors tend to overlook, and are essential to the success of an investment.  I was offered the job, and the importance of those controls is what I stress whenever and wherever I teach.  

Many risk experts fail to recognize the importance of strong internal controls, but they are (to use a football analogy) the "blocking and tackling" of risk management.  Without a solid internal control framework, any hedge fund, financial institution or corporation is likely to suffer a similar demise.  Wheelhouse Advisors can provide a no-cost diagnostic review of your internal control structure.  Visit www.WheelhouseAdvisors.com to learn more.

Gravely Concerned

In yet another example of the ineffectiveness of regulatory oversight, SEC Chairman Christopher Cox admitted today that the SEC failed to act on numerous red flags regarding Benard Madoff's hedge fund turned Ponzi scheme.  With an estimate of $50 billion in losses, the fraud dwarfs those uncovered at Enron and Worldcom that ultimately led to the creation of the Sarbanes-Oxley Act.  Mr. Cox stated the following in today's Wall Street Journal.

"I am gravely concerned" by the agency's regulation of the firm, Mr. Cox said.  According to Mr. Cox, Mr. Madoff "kept several sets of books and false documents, and provided false information involving his advisory activities to investors and to regulators."

To be effective, regulatory oversight must be re-examined and restructured to provide consistent and comprehensive control.  Without it, trust and confidence will not return to our financial markets.