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Schulte Roth & Zabel Navigating A Brave New World

This years Schulte Roth & Zabel’s  (SRZ) 19th Annual Private Investment Funds Seminar stuck a very different pose from last years event.  One year on from the global meltdown of financial markets, languishing institutional certainty and the  pervading crisis of industry confidence has been replaced with a cautious optimism.  The bold swagger of the industry however is gone, in its place a more certain sense of direction and expectation is emerging.  Though managers continue to labor under unachievable  high water marks due to the 2008 market devastation, 2009 marked a year of exceptional performance.   Investment portfolios rebounded in line with the upturn in the equity and bond markets.  Liquidity improved and net inflows into the industry has turned positive during the last quarter as large institutional investors and sovereign wealth funds returned to the sector with generous allocations.  These are taken as clear signs that the industry has stabilized and the path to recovery and the healing of economic and psychological wounds are underway.  Yes the industry will survive and ultimately thrive again but it will do so under vastly different conditions.  The new business landscape will require an industry with a guarded culture of  opaqueness to provide much greater transparency while operating under a regimen of greater regulatory scrutiny.

The 1,900 registered attendees heard a message about an industry at a cross road  still coming to terms with the market cataclysm brought on by unfettered, unregulated markets and excessive risk taking.  SRZ offered an honest assessment in examining the industries role in the market turmoil.  Speakers alerted attendees to an industry at a tipping point.  To survive the industry must adapt to a converging world that believes that uniform market rules and regulations are the surest safeguards against catastrophic systemic risk events.  A global political consensus is emerging  that expresses  support for industry regulation as an effective tool to mitigate the pervasiveness of fraud and market manipulation that undermines investor confidence and ultimately the functioning of a fair and efficient open free market.

Paul Roth, Founding Partner of SRZ,  noted in the events opening remarks that the market is beginning to recover as evidenced by industry AUM once again exceeding the $2 trillion mark;  but  he warned  that any exuberance needs to be tempered with the understanding that the new normal would not resemble the pre-crash world.  The days of  cowboy capitalism and radical laissez-faire investing are clearly over.   Indeed Mr. Roth wryly observed “the industry must develop a maturity about the need for change.  He concluded “that the industry must respond by playing a constructive role in forming that change.”

The conference subject matter, speakers and materials were all top shelf.  Break out presentations on risk management, regulatory compliance, distressed debt deal structuring, tax strategies and compensation issues all reinforced the overriding theme of an industry in flux.  The presenters passionately advocated the need to intentionally engage the issues  to confront accelerated changes in market conditions.  By doing so, fund complexes will be in a position to better manage the profound impact these changes will have on their business and operating culture.  Subject issues like insider trading, tax efficient structuring, hedge fund registration,  preparing for SEC examinations and the thrust of DOJ litigation initiatives and how to respond to subpoenas were some of the topics explored.

To highlight the emerging regulatory environment confronting the industry, a  presenter pointed to the Southerization of the SEC.  This is an allusion to the hiring of former criminal prosecutors from the Department of Justice, Southern District of New York to go after wayward fund managers.  The SEC is ramping up its organizational capability to effectively prosecute any violations of the new regulatory codes.   The growing specter of criminal prosecutions and the growing web of indictments concerning the high profile case of Mr. Raj Rajaratnam of the Galleon Group was presented as evidence of an emerging aggressive enforcement posture being pursued by regulators.  Managers beware!

Presenters made some excellent points about how institutional investors are demanding greater levels of TLC from their hedge fund managers.  This TLC stands for transparency, liquidity and control.  Creating an operational infrastructure and business culture that can accommodate these demands by institutional investors will strengthen the fund complex and help it to attract capital during the difficult market cycle.

The evening concluded with an interesting and honest conversation between Paul Roth and Thomas Steyer,  the Senior Managing Partner of Farallon Capital Management.  The conversation included increased regulatory oversight, compensation issues, industry direction and matching investor liquidity with fund strategy, capacity, structure and scale.   Mr. Steyer manages a multi-strategy fund complex with $20 billion AUM,  his insights are borne from a rich industry experience.  He made the startling admission that Farallon has been a registered hedge fund for many years and he believes that the regulatory oversight and preparation for examiners reviews helped his fund management company to develop operational discipline informed by sound practices.

Mr. Steyer also spoke about scale and that additional regulatory oversight will add expense to the cost of doing business.  Mr. Steyer believes that it will become increasingly difficult for smaller hedge funds to operate and compete under these market conditions.

Another interesting topic Mr. Steyer addressed were issues surrounding investor redemption and fund liquidity.  During last years SRZ conference investor liquidity was the hot topic.  Fund preservation during a period of market illiquidity and a fair and orderly liquidation of an investment partnership were major themes that ran through  last years  presentations.  Mr. Steyer struck a more conciliatory tone of investor accommodation.  He confessed his dislike for the use of “gates” as a way to control the exit of capital from a fund.  In its place he offered a new fund structure he referred to as a “strip” to allocate portfolio positions to redeeming partners in proportion to the overall funds liquid and illiquid positions.  He stated he believed that strategy to be more investor friendly.

Schulte Roth & Zabel has once again demonstrated its market leadership and foresight to an industry clearly in flux, confronting multiple challenges.  These challenges will force fund managers to transform their operating culture in response to the sweeping demands of global market pressures, political impetus for regulatory reform and the heightened expectations of increasingly sophisticated investors.   The industry could not have a more capable hand at the helm to help it navigate through the jagged rocks and shifting shoals endemic to the alternative investment management marketplace.

You Tube Music Video: Beach Boys, Sail On Sailor

Risk: industry, market, regulatory, political

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January 15, 2010 Posted by | hedge funds, institutional, investments, operations, politics, private equity, regulatory, reputational risk, risk management, SEC, sovereign wealth funds | , , , , , , , , , , , , , , , , , , , , , , , , | Leave a comment

Radio Nowhere: Tax Risk Delists Emmis Communications

radiosMisinterpretation of the tax code led to the NASDAQ delisting of Emmis Communications after investors dumped the stock following a restatement announcement.  In an 8-K Filing Emmis announced that its previously filed public financial statements cannot be relied on for accuracy.  Emmis’s stock price has been trading  below $1.00 per share after investors negative reaction to the company’s restatement of earnings and financial condition.  The restatement was necessary after Emmis discovered it improperly accounted for the tax treatment of Federal Communication Commission  (FCC) licensing rights.

Emmis operates a number of radio stations in key metropolitan markets and was forced to restate its financial statements for the past fiscal year and for the first quarter of this year to adjustments it made in its provision for income taxes.   Last year the company wrote down the value of its FCC licenses.  This put Emmis into a loss position leading the company to overstate the benefit for income taxes and understated deferred tax liabilities by $25.3 million for its fiscal year ended February 28, 2009.

Emmis CEO Jeff Smulyan,  released a statement on the company website that read, “Certainly, ‘restating our earnings’ sounds ominous, but our restatement solely relates to a non cash technical tax issue that has no impact on our operations. While there might be big numbers involved and a lot of paperwork being filed, I don’t see anything to worry about.”

This is an interesting example of the consequences of tax risk.  Most tax risk events result in huge settlement amounts, damage to executive reputations and the company brand and sometimes prison terms for the persons and parties involved.  The delisting of the Emmis stock and the severe devaluation of shareholder equity is a more extreme result of the failure to mitigate tax risk factors.

Sum2’s  Corporate Audit Risk Program (CARP) guides corporate tax managers through a thorough risk assessment of exposures to IRS Industry Focus Issues (IFI).  CARP helps tax professionals score threats of IFI risk factors and implement mitigation actions.  The CARP lists Emmis tax problem as a Tier Three IFI risk factor.  It falls  under the communications  technology and media industry guidelines for amortization on intangibles, licensed programs and contract rights.  The CARP is an indispensable guideline and tool that may have provided insights into the tax risk that led to a costly delisting and evaporation of shareholder equity.

Emmis share price closed today at $1.32.  We wish the management, shareholders and employees a speedy remediation to the problems confronting the company and a recovery of the share price to reestablish its listing on the NASDAQ.

You Tube Music Radio: Bruce Springsteen, Radio Nowhere

Risk: tax, shareholder equity, reputation, regulatory

October 15, 2009 Posted by | business, CARP, CPA, IARP, IRS, regulatory, reputation, Sum2, Tax | , , , , , , , , , , , , , , , , , , , , , | 3 Comments