Risk Management: Foundations for a Changing Financial World

CHAPTER 45

THE TEN COMMANDMENTS OF OPERATIONAL DUE DILIGENCE^as

Robert P. Swan III

A well-defined operational due diligence process can help investors uncover risks and avoid the types of operational problems that can lead to a hedge fund blowup. Most issues begin with fundamental weaknesses of internal financial control, lack of separation of duties, and lack of support from top management for the firm’s operational infrastructure. Investors should look for an independent and segregated function that values the books and supports the operational infrastructure. Additionally, the firm’s management should be actively involved in the creation and monitoring of the firm’s control systems.

After 10 years of being involved in managing hedge fund products, overseeing hedge fund operations, and performing operational due diligence reviews, I am glad to see that due diligence of hedge fund operations is receiving some focus from organizations as well regarded as CFA Institute. In this presentation, I want to provide a peek behind the curtain and describe some of the key components of how we at Lighthouse Partners follow certain processes and procedures when conducting our operational due diligence reviews. I would like to stress that if you take nothing else away from this presentation, please recognize the need for a sense of responsibility. One thing we investment professionals should do is make it our responsibility to continue demanding the establishment of an environment of compliance ...