The SEC and Investors Will Put Managers to the Test: To Position Your Firm with Investors, Prepare for a Regulatory Exam
Institutional investors are driving change, and their expectations are beginning to converge with those of regulators. Both are looking for a more developed governance structure within funds holding institutional assets. This change in standards is driven by several factors; one of which is an increasing body of academic literature concluding that operational risks can lead to poor returns on investments.
A new study to this effect has just been published in the Journal of Financial Economics (February 2012, “Trust and Delegation,” by Stephen Brown, et al.). Based on data from 444 hedge funds’ due diligence reports from 2003 to 2008, Brown and his team concluded that “high operational risk can potentially destroy investor value.” They write, “operational risk as we define it leads to direct and indirect losses that can be measured in terms of diminished performance. In extreme circumstances, operational failures can lead to fund failure.” This par