Tuesday, 20 November 2012 12:13

The golden years

As parents advance in age, it often falls on the shoulders of their children or other family members to begin handling their parents' financial affairs, according to Kurt Marlow, Financial Advisor with FirstMerit Financial Services.  "But this is often easier said than done," says Marlow. "Many seniors don’t like giving up control of their finances. They are not comfortable, for many reasons, divulging the details of their personal finances. However, failing to help elderly parents put their financial house in order leaves family members in a difficult situation when there is an untimely death or disability."

To initiate a conversation about this topic with parents and gain their cooperation, Marlow recommends that adult children begin by expressing their genuine concern and desire to help. A family meeting can sometimes be a helpful forum for this conversation.

"There are many different ways to go about planning a family meeting," says Marlow. "To start, I encourage my clients to meet with me separately beforehand. For example, I will visit with my mature clients privately to discuss their financial situation to make sure I understand the needs and concerns they have. We then set up a separate appointment with the children or a close family member to discuss the parent’s financials and long-term care wishes."

During the family meeting, extensive notes are taken outlining an inventory of the parents' assets. Marlow provides a form for their use; a Family Discussion Checklist, a tool that is unique to FirstMerit. The Family Discussion Checklist is designed to help organize all important financial documents in one place. It details monthly income and expenses, bank statements, investment account statements, insurance policies, long-term care insurance, trusts, loans and mortgage documents. The checklist identifies which financial documents currently exist, where they are located, and which documents are still needed.

After the checklist is complete, Marlow works with the family to analyze the parent's financial situation and see what help may be needed.

"I try to find out what their concerns are, or whether there is a particular piece of the financial puzzle they are concerned with," he says. "The answers vary from family to family based on each person's unique financial situation and goals. For example, we discuss adding a Power of Attorney, or after consulting a tax professional, we may decide to add a trusted family member as a joint owner or other similar arrangements may be a solution. In some instances, beneficiaries may be added to the parent's accounts so that the designation is in place if something unexpected happens to the parent."

"No matter what solutions are decided upon by the family," adds Marlow, "the service that many of our family clients value highly is the convenience and assurance of having a trusted advisor to work alongside them."

The process for connecting generations and coordinating the financial affairs of the older generation can be comprehensive, but at the end of the day, it can be a unifying experience for the entire family when parents have the assurance that their wishes are being followed even after they are gone.

For more information on managing finances for the elderly in your life, contact Kurt Marlow, Financial Advisor, FirstMerit Financial Services Inc., at (708) 529-2158.

Securities offered through FirstMerit Financial Services, Inc. Member FINRA, SIPC; Advisory Services offered through FirstMerit Advisors, Inc.; Insurance products offered through FirstMerit Insurance Agency, Inc., affiliates of FirstMerit Bank, N.A.

Investment and Insurance Products are: • ?Not FDIC Insured ? • May Lose Value • Not Bank Guaranteed ? • Not a Deposit • Not Insured By Any Federal or State Government Agency 

Published in Cleveland
Tuesday, 20 November 2012 12:08

The golden years

As parents advance in age, it often falls on the shoulders of their children or other family members to begin handling their parent's financial affairs, according to Ed Wojciechowski, Financial Advisor with FirstMerit Financial Services.  "But this is often easier said than done," says Wojciechowski. "Many seniors don’t like giving up control of their finances. They are not comfortable, for many reasons, divulging the details of their personal finances. However, failing to help elderly parents put their financial house in order leaves family members in a difficult situation when there is an untimely death or disability."

To initiate a conversation about this topic with parents and gain their cooperation, Wojciechowski recommends that adult children begin by expressing their genuine concern and desire to help. A family meeting can sometimes be a helpful forum for this conversation.

"There are many different ways to go about planning a family meeting," says Wojciechowski. "To start, I encourage my clients to meet with me separately beforehand. For example, I will visit with my mature clients privately to discuss their financial situation to make sure I understand the needs and concerns they have. We then set up a separate appointment with the children or a close family member to discuss the parent’s financials and long-term care wishes."

During the family meeting, extensive notes are taken outlining an inventory of the parents' assets. Wojciechowski provides a form for their use; a Family Discussion Checklist, a tool that is unique to FirstMerit. The Family Discussion Checklist is designed to help organize all important financial documents in one place. It details monthly income and expenses, bank statements, investment account statements, insurance policies, long-term care insurance, trusts, loans and mortgage documents. The checklist identifies which financial documents currently exist, where they are located, and which documents are still needed.

After the checklist is complete, Wojciechowski works with the family to analyze the parent's financial situation and see what help may be needed.

"I try to find out what their concerns are, or whether there is a particular piece of the financial puzzle they are concerned with," he says. "The answers vary from family to family based on each person's unique financial situation and goals. For example, we discuss adding a Power of Attorney, or after consulting a tax professional, we may decide to add a trusted family member as a joint owner or other similar arrangements may be a solution. In some instances, beneficiaries may be added to the parent's accounts so that the designation is in place if something unexpected happens to the parent."

"No matter what solutions are decided upon by the family," adds Wojciechowski, "the service that many of our family clients value highly is the convenience and assurance of having a trusted advisor to work alongside them."

The process for connecting generations and coordinating the financial affairs of the older generation can be comprehensive, but at the end of the day, it can be a unifying experience for the entire family when parents have the assurance that their wishes are being followed even after they are gone.

For more information on managing finances for the elderly in your life, contact Ed Wojciechowski, Financial Advisor, FirstMerit Financial Services Inc., at (708) 529-2158.

Securities offered through FirstMerit Financial Services, Inc. Member FINRA, SIPC; Advisory Services offered through FirstMerit Advisors, Inc.; Insurance products offered through FirstMerit Insurance Agency, Inc., affiliates of FirstMerit Bank, N.A.

Investment and Insurance Products are: • ?Not FDIC Insured ? • May Lose Value • Not Bank Guaranteed ? • Not a Deposit • Not Insured By Any Federal or State Government Agency 

Published in Chicago

Dividends have accounted for 40 percent of total returns in the market since 1940. Some investors are concerned about recent stock price increases, but there still is room to invest in dividend-paying stocks, especially for the long term, says Sonia Mintun, vice president and portfolio manager at Ancora Advisors LLC.

“For the long term and at current valuations, particularly given historically low payout ratios, dividend-paying stocks can see strong relative and absolute performance. The outlook is enhanced by near all-time low U.S. Treasury yields and the Federal Reserve’s extended dovish position on interest rates,” she says.

Although the upcoming election and global economic environment are areas for concern, Mintun says an emphasis on high-quality dividend-paying stocks at low valuations should cushion investors from volatility and provide real returns over the long term.

Smart Business spoke with Mintun about the current stock market and how dividend-paying stocks remain a smart investment.

With the recent run-up in equities, is the dividend-paying strategy overvalued or a crowded trade?

Over the last year or more, the dividend theme has been the popular trade and the market has run up. There are a number of ways to evaluate if the market — and therefore dividend-paying stocks — is overvalued. You can examine whether it is trading at lower-than-average yields, or higher-than-average valuation ratios such as price-to-earnings (P/E), price-to-book (P/B) or price-to-cash flow.

The current market’s value is dependent on an investor’s time frame and risk tolerance. Is it overvalued for the next several months? It is possible we could see some pullback, but looking over the long term, it is our view that dividend stocks are not overvalued. The trailing P/E ratio of the S&P 500 index is around 14, which is lower than its historical norm and nowhere near where it was during the tech bubble when P/E ratios were closer to 50. While you can argue that the economic growth outlook is sluggish, companies have become operationally leaner, which has helped boost profit margins. They have better positioned their balance sheets by refinancing debt at extraordinarily low interest rates and have historically high cash levels. Lastly, with regard to dividend payers in particular, yields are at close to seven-year highs, while payout ratios are low, suggesting current yields are well supported by earnings. So overall, our opinion is that dividend-paying stocks remain attractive for long-term investors, especially in comparison to fixed-income yields.

What sectors have performed better and may be perceived as overvalued?

Defensive sectors such as consumer staples, health care and utilities have attracted a lot of capital and could be perceived as overvalued. Their P/E multiples compared to the overall market are trading at premiums to their five-year averages, but it is not a significant premium. Utilities, for example, are the most correlated sector, with 10-year treasury yields that have an 80 percent correlation since 1990. If you think that rates are going to stay low for some period, utilities may not be overvalued based upon the five-year averages.

What dividend-paying sectors have underperformed?

Economically sensitive stocks, such as energy, industrials and materials, have fared the worst, largely due to fears about slower growth in emerging markets and from concerns in Europe. However, many stocks in these sectors are trading at attractive discounts to their historical valuation ratios. They have ample cash on their books, generate consistent cash flows and could see improving profitability with higher commodity prices and demand if global stimulus takes hold.

What impact will the potential tax changes have on dividend-paying stocks?

A potential dividend tax increase has concerned some investors about owning dividend-yielding stocks. In 2001 and 2003, dividend tax cuts were put into place that reduced the dividend tax rate to 15 percent from 35 percent. These cuts are set to expire at the end of this year unless Congress extends them or passes new legislation. If no legislation is passed, taxes return to a top marginal rate of 39.6 percent. This tax increase may be a short-term negative for stocks and high-yielding stocks.

However, history has shown that tax increases do not have a long-term negative effect on dividend-paying stocks, as stocks typically recover after six months or so following an increase. This may be because an estimated 50 percent of equity held is owned by tax-exempt entities — such as qualified plans, foundations and foreign investors — all of which are somewhat indifferent on taxes. In addition, when tax increases are anticipated, it has typically not been problematic over the long term. For example, beginning in 2013, a new Medicare contribution tax of 3.5 percent will be imposed on investment income. This proposed tax increase has had minimal effect on the stock market so far.

What is the long-term outlook for dividend-paying stocks?

Longer-term dividend-paying stocks remain an attractive option for risk-averse, equity-oriented investors. Dividends provide a cushion during poor equity markets and are relatively stable over time. Consequently, by being less volatile and being more disciplined with capital because of the dividend policy, dividend-paying companies have outperformed non-dividend-paying companies for more than 80 years. Additionally, with dividend payout ratios near historical lows and weighty cash balances, companies may return more cash to shareholders in a low-growth environment. Given today’s low interest rates and continued global economic turbulence, we see dividend paying stocks as attractive now and for the long term.

Sonia Mintun is a vice president as well as an Investment Advisor Representative of Ancora Advisors LLC (an SEC Registered Investment Advisor). In addition, she is also a Registered Representative of Ancora Securities, Inc. (Member FINRA/SIPC).  Reach her at (216) 593-5066 or sonia@ancora.net.

Insights Wealth Management & Investments is brought to you by Ancora

Published in Cleveland

Borrowers often assume that because they have made all their payments in a timely manner, renewing their line of credit will be as easy as it has been in the past. However, this is not the case, says Kenneth R. Cookson, attorney with Kegler, Brown, Hill & Ritter.

“The lending environment is different now and the conditions that allowed some borrowers to run the lines up to the maximum amount and simply pay the interest have passed,” says Cookson. “While in earlier years, it was almost automatic that timely payment of the monthly interest alone would make renewal easy, today, being a ‘loyal customer’ is nearly irrelevant to the renewal process.”

Smart Business spoke with Cookson about the lending environment and how changing conditions have affected it.

What challenges are banks currently facing?

In the post-Great Recession regulatory environment, banks are facing a combination of focused regulations and declining values in real estate portfolios and borrowers. They have pressure on their capital requirements and reserve requirements. When a loan is classified as less than perfect, there has to be a reserve established from a bank’s capital to offset the portion of the loan that is in jeopardy, which can eat into capital reserves quickly.

Banks are being subjected to a loan-by-loan analysis by regulators and they are trying to get ahead of that by going through their own portfolios to figure out which loans are speculative and which are not.

Further, a bank may feel regulatory pressure when it has a high concentration of loans in one industry with similar borrowers, so it may hedge its risk. The borrower may be surprised that the line of credit is not extended because the business has made payments on time, but the bank may feel that it is too exposed in that particular area.

How are banks coping with these regulatory requirements?

They are certainly increasing their lending standards. The ratio of loan-to-value has come down, particularly in the real estate market, where a 70 percent loan-to-value ratio is not an unusual request. When you couple that with a decline in real estate values, it really amplifies the state of the conditions and the difficulties for both lenders and borrowers.

What is happening to borrowers?

Borrowers, in many cases, are being caught unaware. They have had a line of credit with a bank for many years and don’t deal with a commercial banker very often. They will send in financial statements annually, the revolver is generally renewed and the rate goes up or down according to market conditions.

Now, bankers are having trouble renewing those lines of credit and are reducing them, or imposing other requirements that have not been enforced previously, such as not allowing borrowers to take out the maximum on their line and just pay the interest for a full year. The borrowers express surprise, asking, ‘Why shouldn’t making timely payments make the renewal of that loan automatic?’

The answer begins with the regulatory requirements on banks and concentration issues, the value of the portfolio of the collateral supporting the loan, an increase in loan-to-value ratios and cash flows.

If it is a real estate loan or one backed by accounts receivable, and the value of either or both has gone down, leading to the appropriate ratios established in the loan document to not be in line, the loan could be classified downward. Borrowers need to understand a bank’s regulation reviews, internal reviews and lending policies, and be prepared for that.

What can borrowers do to help themselves through this?

Borrowers should make sure that their financial statements are current, accurate and complete. Look at your internal records and make sure that your accounts receivable are all good, and if they are not, work to discover the problems before the bank does.

Also, know your business plan and what your five or 10 largest customers are doing. If you learn that of your two lines of business, only one is profitable, you should shift your resources to the more profitable of the two.

Companies can get weighed down by the history of their operations and not take a critical look at their business model, business plan, customer array and pricing policies. Examine your business model as if you were starting fresh.

There is no shortage of examples of businesses that hypothetically have grown but their profits have not gone up proportionally. Increasing sales doesn’t necessarily mean higher profits because of other factors, such as margins and collectability issues. You have to scrub the numbers to see what you are doing right. You may have to cut back sales to better serve customers at higher margins in order to make more money.

How can banks and borrowers each adjust during this period of transition?

You have to assume that we are going to come out of this Great Recession and that the economy will be back in growth mode. This takes patience and understanding from both lenders and borrowers.

Lenders want to make loans. They need to lend money because that is how they get a return on the capital that has been invested. And borrowers need to be granted loans in order to make that happen.

Kenneth R. Cookson is an attorney at Kegler, Brown, Hill & Ritter. Reach him at (614) 462-5445 or kcookson@keglerbrown.com.

Insights Legal Affairs is brought to you by Kegler, Brown, Hill & Ritter Co., LPA

Published in Columbus
Saturday, 01 September 2012 13:40

Five things to know about executive compensation

Well-drafted executive compensation programs aren’t just used to recruit and retain top-level leadership to your company. Public and private companies can tailor executive pay packages to encourage executives to achieve certain goals.

“We can put strings on short-term and long-term benefits to drive executive behavior, and that’s one of the things that’s really coming to the forefront now,” says Ted R. Ginsburg, CPA, JD, a principal with Skoda Minotti.

Smart Business spoke with Ginsburg about leveraging executive compensation.

What are the key components of an executive compensation program?

In general, an executive compensation program consists of four key parts. These are base pay, annual bonus, long-term incentives and perquisites, which could include car allowances, country club memberships, executive physical programs, security services and use of the company airplane. Because of recent economic events and more scrutiny by shareholders, perks are not such a big part of the package anymore; employers are providing higher base pay and instructing executives to acquire the perks on their own.

An optional component is a sign-on and/or retention bonus. A sign-on bonus is appropriate when trying to hire an executive from another company who would lose a bonus if he or she left. The retention bonus — a promise to stay through a certain date or event in order to receive a bonus — is used when you have incurred hard times and worry the executive is going to leave.

How does executive compensation differ in a public and private company?

There are some significant differences, and oftentimes, private companies are at an inherent disadvantage. A public company normally provides a long-term incentive using either a stock option or restricted stock. A stock option allows executives to purchase shares at a stated price while he or she remains employed; a restricted stock program gives executives a share of stock outright after meeting certain targets. Stock doesn’t drain cash flow, often doesn’t immediately reduce earnings and can have favorable tax treatment for the company and the recipient. In a publicly traded company setting, the recipient can usually turn around and resell the shares on the open market immediately. The total pay package of chief executives of major public Cleveland corporations may comprise 60 to 70 percent in company shares.

Many executives in private companies don’t want to receive stock unless they already own a substantial company stake. Executives would need to pay income tax on the stock and can’t sell part of the shares to cover the amount. Also, executives usually must sell the stock back when they leave in exchange for a cash payment made over time. Furthermore, private company owners might not share financial information with executives so the value of the ownership interest is unclear.

What can a private company offer someone from a public company instead of stock options?

Some private companies award only base pay and an annual bonus, but attracting a senior-level executive from a public company is difficult without a long-term incentive program. There are programs that provide a cash payment based on company performance and the current company value over a number of years, making executives feel as if money has been put aside for their future. Two types of long-term incentive programs are:

  • Phantom stock — an owner gives executives a check representing the full value of a number of shares of stock when they leave.

  • Stock appreciation rights — an owner gives executives a check when they leave, which equals the number of rights given to them multiplied by the difference between the value of the stock when it was awarded and when they leave. Mimicking a stock option, it rewards executives for increasing the value of the company.

These programs often have a vesting schedule stating an executive leaving before a certain time does not receive the entire benefit.

Another methodology is a change of control payment, where an owner planning to sell or transfer the business gives the executive a check based on the sale price or value of the company at the time ownership is transferred.

Some larger private companies with the necessary liquidity also use long-term cash incentive programs. Over a period of time, if revenue is up or costs are down, cash is put aside for when the executive leaves.

Why do long-term incentive programs help an employer?

These programs act as retention devices. They focus employees on long-term performance rather than maximizing annual bonuses and they don’t drain cash immediately as they are deferred payment obligations.

Long-term incentive programs are familiar to public company executives. If a private business owner offers to pay to replace the value of stock options lost because the executive left for a private company, the recruited public executive might ask what he or she is going to get for subsequent years.

Finally, they allow for a trial period, giving  the option of cutting him or her loose early.

Why are employers moving away from discretionary annual bonuses?

With discretionary bonuses, private company executives walk away without knowing what they did to earn it and how to repeat it. Many businesses now give bonuses based on company performance.

Well-drafted programs have easily measured goals that drive behavior and set annual priorities. Long-term, multiyear program goals relate to financial performance and other forward-thinking items, such as establishing a new geographic market or bringing a certain number of products to market. If the goals aren’t met but executives put in the effort, ownership can always give discretionary bonuses. This type of program helps employers manage the executive’s expectations and creates transparent working conditions.

 

Ted R. Ginsburg, CPA, JD, is a principal with Skoda Minotti. Reach him at (440) 449-6800 or tginsburg@skodaminotti.com.

Insights Accounting & Consulting is brought to you by Skoda Minotti

Published in Cleveland

In today’s economic environment, businesses have to get the most out of their employees and remote banking allows employees to focus on tasks that benefit the business. By eliminating the need for them to leave the office to make deposits and handle other banking tasks, businesses can save time and increase productivity, says Stephen Klumb, senior vice president and chief lending officer for National Bank & Trust.

Remote banking also offers a high degree of accuracy and control because you’re handling your own transactions, you are able to keep a close watch on which transactions have occurred and when they are finalized.

“It’s almost like being your own banker,” says Klumb. “You’re making transactions, moving your money around, setting up automatic bill paying and handling your own deposits, all from your own office.”

Smart Business spoke with Klumb about the benefits of remote banking and how it frees businesses to customize their banking relationship.

Are companies limited to banking at the nearest location?

Some people have the mindset that walking into a physical location to service their banking needs is necessary. That may be true for retail customers, but from a commercial perspective, it really isn’t. Our commercial team goes to customer locations, and thanks to technology, we can do far more for them. Commercial customers can, for example, use a remote capture system to make deposits. With remote capture, a small machine at your business allows you to run checks through and get credit for the amount at your bank the same day.

Another remote banking option is Automated Clearing House, or ACH. This secure payment system allows your customers to send payments they owe you electronically from their bank directly to your bank account, speeding up your accounts receivable. You can also set up the reverse, allowing transactions to leave your account and be automatically received by your vendors.

How can a business keep track of its remote transfers?

Commercial banking customers can track their transfers with online banking. Those customers can sit at their computer, sign onto the bank’s website with total confidence that their information is secure and discrete, and transfer money and make payments.

When it comes to payroll, Positive Pay is an option in which no checks are paid until you release them, which helps eliminate the possibility of fraud. You can also get involved in Bill Payer, which sets up regular, automatic payments of bills, similar to what consumers use for personal use. Further, just as consumers can access cash and make deposits 24 hours a day through ATMs, so can businesses. Commercial customers can also use mobile banking on a phone for their business needs, and new apps are making this method increasingly popular.

Is there any reason a business owner would need a physical bank?

In regard to having a need for a physical bank, your commercial lender should set up meetings once per quarter to keep up with what’s going on with your accounts both past and present. But you can also go online, pull up your accounts, your transactions and your balances, and you’ll see the same things a branch manager sees. This service, and others, like Remote Capture, will minimize the trips made to a banking office.

In the event that you’d like to discuss a grievance, there is a number you can call that will put you in touch with a representative to handle it.

Most borrowers don’t call a branch if they have a problem with their commercial loan, they call their commercial lender. Your assigned commercial loan officer is available to handle any issues, typically within 24 hours, and can be accessed by cell phone and email.

Today, when closing loans, many lenders will go to the customer, as a lender’s office is usually his or her cell phone. Lenders will most often meet business owners where they work to close loans or review documents. There also may be occasions when a business owner might not want employees to know he or she is working with a bank, so lenders can meet them anywhere they’d like.

Are there costs associated with remote banking services?

Often, the costs associated with remote banking services are absorbed by the time and extra costs often incurred when not performing these activities electronically. Other costs may vary depending on banking activity and account relationships. Overall, most customers find remote banking services to be a very cost effective part of their financial practices.

How computer savvy do a company’s employees need to be to utilize electronic banking services?

Most companies on the commercial side have accountants or managers who are very knowledgeable when it comes to these things. And once they’re trained to use the systems, the benefits most often outweigh any anxiety.

However, to ensure a smooth transition, when a bank sells the service, it generally teaches customers how to operate them. For example, with remote capture, bank representatives will explain how to operate the machine when they bring it to the client’s place of business and they’ll leave a phone number for questions.

With online banking, there is a tutorial available to walk the user through the program, and in some cases, the person selling the service will take along a laptop to show those at the business who will be using the service how the programs work.

Stephen Klumb is senior vice president and chief lending officer with National Bank & Trust. Reach him at (800) 837-3011.

Insights Banking & Finance is brought to you by National Bank and Trust

Published in Cincinnati

A fundamental investing concept is that investors need to be compensated for taking on additional risk.  However, investors often do not anticipate operational risks, and as a result, are often not compensated for them, says Todd E. Crouthamel, director, Audit & Accounting, at Kreischer Miller, Horsham, Pa.

“Operational risk can be difficult to price into the risk premium because human error is unpredictable,” says Crouthamel.  “Therefore, many investors are left to assume that human errors will be prevented by the managers’ systems and controls, in order to rationalize hiring that manager. However, this is not always the case.”

Smart Business spoke with Crouthamel about how to differentiate between investment risk and operational risk.

What is investment risk?

Investment risk can be defined simply as the risk that the actual return on an investment will be lower than the investor’s expectations. Many investors are able to assess investment track records and investment models to decide if the potential rewards are worth the perceived risks in an investment. This type of risk is also readily measurable using various statistical measures, including:

  • Alpha, the excess return of an investment relative to the return of the benchmark
  • Beta, the measure of a volatility relative to the overall market
  • R-squared, the measure that represents the percentage of an asset’s movement that can be explained by movements in the benchmark
  • Standard deviation, the measure of the dispersion of data from its mean
  • Sharpe ratio, which describes how much excess return is generated for extra volatility of holding an asset

What is operational risk?

The ratios described above are all built on certain assumptions, including that volatility equals risk. These ratios all derive risk measures based on quantitative factors; however, they do not consider qualitative factors, including the investment manager’s internal controls, design and implementation of its systems, and oversight of its employees. This is operational risk.

Human error makes operational risk unpredictable. Many investors may assume that human errors are prevented by the managers’ systems and controls, but that is not always the case. Consider the following situations:

  • You hire Manager A to manage a large cap equity portfolio, and instead, Manager A finds better opportunities in the small caps and rationalizes investing your portfolio in small caps in the interest of earning you a better return. This guideline violation results in your portfolio being overweighted in small caps and minimizes your exposure to large caps.
  • Manager B was recently examined by the Securities and Exchange Commission (SEC) and the SEC concluded that Manager B’s compliance program was wholly inadequate.
  • Manager C has a trader with inappropriate access rights to override controls in the compliance system. The trader executes trades that are in violation of the investment guidelines and conceals these through the inappropriate access rights so these securities are not identified as investment guideline violations.

These examples are real. While some of these risks may be identified in the risk measures described previously, many go undetected until disaster strikes and losses pile up.

How can investors protect themselves from operational risk?

Elimination of operational risk is virtually impossible; however, it can be mitigated with some additional due diligence. Consider the following best practices:

  • Review the Form ADV. If your investment manager is registered with the SEC, go to www.adviserinfo.sec.gov and read the adviser’s Form ADV, which consists of two parts. Part I provides details on the business, ownership, client base, employees, affiliations and disciplinary actions. Part II is a narrative that describes the services offered, fees, conflicts of interest and the backgrounds of management. Make sure that this information is consistent with what you already know about the adviser.  If you are uncomfortable with any of the disclosures, make additional inquiries of the investment manager. If you are still not satisfied, consider another manager.
  • Read the investment manager’s most recent SEC examination letter.  The SEC conducts routine examinations of investment managers’ compliance systems and issues a letter detailing violations and enhancements that the investment manager should make. If your investment adviser is reluctant to share this letter with you, consider another manager who is more transparent.
  • Make inquiries of the investment manager regarding its systems and internal controls surrounding compliance with investment guidelines. The compliance system should be automated, and overrides of transactions outside of the investment guidelines should require more than one sign off, preferably by someone who is independent of the trading and investment management process.
  • Make inquiries of the investment manager regarding the financial strength of the company. An investment manager that is having financial difficulties may be more likely to take bigger risks.
  • Read the investment manager’s report on internal controls.  Many investment managers have a report that is prepared by an independent third party that tests various internal controls surrounding establishing new accounts, trading, reconciliation and accounting. This report generally details the testing performed and the results.
  • If you are not confident in your ability to conduct operational due diligence, consider hiring a third party to conduct it on your behalf.

While these best practices may reduce your exposure to operational risks, there is no substitute for a healthy dose of skepticism. If an investment manager’s returns look too good to be true, they probably are.

TODD CROUTHAMEL is a director, Audit & Accounting, and a member of the Investment Industry group at Kreischer Miller. Reach him at (215) 441-4600 or tcrouthamel@kmco.com.

Insights Accounting & Consulting is brought to you by Kreischer Miller

Published in Philadelphia