Need for Fund audit seen as essential
How important is it to have an auditor for a fund? Should all funds be
audited?
The quality and usefulness of audits for funds was thrown into stark
relief with the revelation that the Madoff fraud was partially concealed by
the lack of a rigorous review of the company’s accounts. Whether funds
are regulated or not, most investors expect at least a yearly audit of the
fund by a reputable accounting firm.
Anthony Pace and Noel Mizzi at KPMG in Malta think the reason behind
audits can be traced back to the product itself. They think the need for an
audit is driven by the need to oversee the stewardship function conducted by
persons that were not the owners of capital. According to the pair, owners
wanted a way to ensure that stewards behaved in an appropriate manner.
In this respect, a fund is not different from the most common form of
incorporation (that is, the limited liability company).
The fact that a fund has variable share capital and its type may vary
from retail to different levels of professional investor funds does not
reduce the relevance of the audit for these funds, they say.
Professional investor funds (PIFs) are less regulated since they are open to
a more selective group of investors, usually high net worth individuals or
institutions with a sound knowledge of the markets. A less-regulated
environment also allows more flexibility in investment activities and
potentially higher absolute returns albeit more exposed to higher risk of
loss, say Pace and Mizzi.
Some PIFs are not required to entrust their assets to a custodian as a prime
broker is considered to be sufficient. Perhaps, suggests Mizzi and Pace, the
fact that in general most of a fund’s functions are subcontracted to a
number of service organisations while the underlying assets are often the
more complex and volatile products means that auditing is significantly more
than a statutory requirement.
The investors have other objectives to achieve, particularly those that
relate to other stakeholders of the fund, such as a financier providing the
necessary leverage, potential investors, significant counterparties,
regulators and tax authorities and other creditors, they conclude.
Others at KPMG believe it is of “paramount importance” that fund
directors appoint an independent auditor to comply with any legal
requirements, to challenge and to corroborate the valuation and financial
reporting provided by the third party administrator and/or investment manager
and to provide informed comment on the application of new and existing
accounting standards.
Interestingly, KPMG notes that managed accounts often are not required to be
audited and thinks investors may want to request some form of independent
assurance over valuation and title that may not otherwise be available.
“Some hedge funds do not automatically require an audit,”
says Stuart McLaren at Deloitte. “In those instances the decision
should be left to the investors’ discretion.” According to
McLaren, investors should determine if an audit is necessary based on their
relationship with the fund manager and the fund’s other service
providers.”
“We would suggest that where funds are available to the public they
should always be audited,” he concludes.
Importance of auditing
At PricewaterhouseCoopers in the Cayman Islands Colin Hanson agrees it is
“very important” for funds to be audited regularly. He believes
investors are now focusing on the strength of service providers and the lack
of an audit would “raise questions and create a perception of a
problem”.
Hanson thinks it is more likely that problems could exist without an audit
and the process itself improves accountability. “Generally, an audit
improves transparency via increased disclosure,” says Hanson, adding
that the choice is often determined by the management or required by
regulators, by law or through constitutional documents forming the fund.
Julian Young at Ernst & Young in London sees a fund audit as
“one of the essential elements of good governance, as it provides
investors with confidence that the fund’s annual accounts have been
properly prepared and give a true and fair view of its performance for the
period. Without an audit the accounts may be opaque and poorly drafted, or at
worst, deliberately misstate assets or performance.”
He thinks that by appointing a competent, independent auditor, along with
other good governance elements such as an independent board of fund directors
and high-quality service providers, helps to provide a “check and
balance on the activities of the investment manager, provides a counterpoint
to the judgemental areas, such as investment valuation and serves as a useful
deterrent to fraud.”
At KPMG in Dublin,
Barry Winters and Garrett O’Neill agree with their colleagues that the
importance of appointing an auditor to an investment fund cannot be
underestimated. They believe this is particularly the case where third
parties invest funds with an investment manager.
Both say the appointment of an auditor helps protect investors and provides
independent reporting on the financial statements and internal controls of an
investment fund including systems and controls within the administrator.
Another important function of an auditor is to consider fraud controls
and issue appropriate audit recommendations.
Winters and O’Neill conclude it would be unusual if an investment
fund were not independently audited, particularly where there are external
investors involved
They note the offering memorandum of an investment fund will generally
require that an audit is carried out every 12 months. An annual audit is also
usually required by law or regulation
Article by Margie Lindsay
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