Wednesday, January 7, 2009

Choice of audit firm – a request for comments from readers

We are in the process of setting up a small fund.  I don’t want to use the word “hedge fund” because we really will take positions rather than try to run a balanced book.  

And we need to choose an audit firm.  We won’t use leverage, we will be global and we intend on having proper third-party custody arrangements.  We should present low audit risk –we will pass the simple due-diligence tests which Madoff (should have) failed.  

Our current choice is a medium sized West Coast firm – a big name in San Francisco – but generally unknown outside that foggy town.  They have a professional staff of about 100 – they are not a fly-by-night three person operation.

However in the post-Madoff era the words “who is that auditor?” have a different meaning.  We are leaning towards a bigger name auditor – a big four firm.  That is a pity because our auditor has genuine expertise – we chose the partner because we like and trust him.  He will help keep us out of the many international tax problems that could befall a global fund for American partners running out of Australia.

The smaller firm in our opinion offers genuinely less risk (namely tax risk) for us and our clients and at a lower cost than a big four firm.  

So – how do people really feel about the 100 professional audit firm?  We want to use them.  Will it matter that you – our potential clients – have not heard of them?

And does it make any difference that three of the big four and the number 5 audit firms are all likely to face serious Madoff problems because they audited Madoff feeders?  It is going to be problematic for everyone now that Ernst and Young, KPMG and PWC all have a reasonable chance of failing as a result of auditing Madoff feeder funds.  (It seems that they spectacularly failed to do their job.)

This leads to another policy question: how do you build another big four (or six).  This four are all discredited!  Is there a role for an accounting firm with 200 partners capitalised with 200 million dollars?  How do you do start that sort of thing anyway?  


Anonymous said...

Use the best firm and ask them to offer references, if investors aren't familiar with them.

Not sure you want investors who need the labels and don't understand quality, or have the capability and intelligence to do some simple background checking.

Anonymous said...

it depends quite a bit on who your investors are and what you need to do to make a good impression with them.

i would say that if you are looking for long term alignment with your investors (these days a must if you are taking illiquid positions) you should do what is best for you and for them and you already know what that is. this requires a certain kind of investor though; i don't know what you have.

Pete-0 said...

references, references, references, and not just names for the sake of names, but ones that will take calls and be forthcoming about the firm and, more importantly, the partner in charge. by forthcoming i mean willing to express both positive and negative feedback

also be relevant to get other "fund" clients of the firm you're considering to agree to allow you to disclose those relationships. you will be judged by the company you keep.

Anonymous said...

You go with one of the big four. No choice. The legal liability of any other choice not to mention the marketing aspects leave you no option.

As to your question about creating another credible alternative. Look at the rating agencies. Discredited to the hilt yet the Fed still relies on them. Big is impossible to displace, unfortunately.

A world turned upside down if you will.

Shaun D said...

I went through accounting in University, and though I did not end up in that career path, I have many friends who did.

I would say as someone who is knowledgeable about the accounting industry, that choosing a big 4 accounting firm is irrelevant to me.

It is true that the best and brightest university students will in large part go to one of the big four (big six in my day), but it is also true that in most part once the relevant accounting designation and experience is received (CA, CPA, etc), those same best and brightest will be headed off for more profitable jobs in the private industry.

A big four accounting firm, has increased costs, and has a slowness associated with it, that a good local firm will not.

I would be more impressed with a company that chose a specialized local firm for an auditing job, rather than a company that chose the 'safe' choice.


t said...

The custodian will do the month-to-month pricing, so provided you chose a reputable one, you should be OK.

Anonymous said...


Will the fund be available to investors in australia?

Anonymous said...

Big 4. It's almost nothing to do with Madoff.

Would you drink Ace Cola instead of Coke? It may be better, i've never tried it.

Anonymous said...

Don't choose PWC -see Satyam -7 years of fraudulent accounts!

Anonymous said...

have polled a few people in the office here. the view of most people is that despite the big 4 being of very questionable quality a big 4 name is still considered a mark of independence. i would suggest that you split your accounting providers. get your tax and business advice from the small firm, but only the auditing done at a big 4.

Anonymous said...

I don't think anyone thinks bigger is better anymore. Remember Arthur Anderson? They were big.

I think the firm you described, if it has a history of integrity, will be a better choice than the Big N, however many N is after the world economy sees the light of day again.

Anonymous said...

If you're looking for a firm that has carved out a niche working for hedge funds, perhaps you should consider Rothstein Kass. We've been using them for our global macro fund, and while they aren't cheap, they are well-regarded, I believe. Also, choosing a third-party administrator is very important in this new environment. Good luck.

Anonymous said...

Well, Satyam chairman resigned yesterday and admitted to a giant accounting fraud to hide several years of inflated earnings. The auditor was PwC.

Anonymous said...

There are still plenty of gut feeling / smell test decisions being made. So for a first impression a big 4 name could matter, despite their unhealthy share of mess-ups.
However, investors who do their homework oughtn't to be afraid if a name isn't immediately familiar, as long as there's a pile of information and references ready at the first phone call.

Anonymous said...

@Neil - Virgin Cola was okay.

Anonymous said...

use the SF firm.

If investor X is leery about using a non-Big 4 accounting firm, let them walk....and have them take comfort with ENE and SAY shareholders, LOL!

choosing the best audit firm (in your view) is more important than maximizing AUM.

good luck.

just another anon. opinion.

Anonymous said...

Worldcom, Enron, Siemens, Maddoff, Satyam.

Satyam is particulary instructive because the staw that broke that neck was the due diligence for putting it on the market.

==> change the auditors once in a while and make this an explict policy.

Francine McKenna said...

For a perspective on this issue, take a look at my post: Hedge Funds and Their Auditors - It's Good To Be Aggressive

Anonymous said...

Maybe look at the SF firm the way you'd evaluate a company. Can you figure out where it will be in five years rather than today? Are they gaining clients as a result of the current mess or losing clients? Do they have pricing power?

General disclaimer

The content contained in this blog represents the opinions of Mr. Hempton. You should assume Mr. Hempton and his affiliates have positions in the securities discussed in this blog, and such beneficial ownership can create a conflict of interest regarding the objectivity of this blog. Statements in the blog are not guarantees of future performance and are subject to certain risks, uncertainties and other factors. Certain information in this blog concerning economic trends and performance is based on or derived from information provided by third-party sources. Mr. Hempton does not guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. Such information may change after it is posted and Mr. Hempton is not obligated to, and may not, update it. The commentary in this blog in no way constitutes a solicitation of business, an offer of a security or a solicitation to purchase a security, or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author. In particular this blog is not directed for investment purposes at US Persons.