Operational Due Diligence
Best Practices
A presentation to:
13 February 2013
Table of Contents
1. Current Industry Landscape
2. Due Diligence in Practice
3. Case Study
4. Laven Partners
Current Industry Landscape
Due Diligence In Practice
A Case Study
Laven Partners
Page. 2
Current Industry Landscape
Current Industry Landscape
Due Diligence In Practice
A Case Study
Laven Partners
Page. 3
Direct Investing
Movement towards direct investing:
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Investors are increasingly considering surpassing the investment vehicles and directly
investing in real assets;
choice of assets constitute:
 infrastructure e.g. toll roads;
 drilling assets e.g. oil rigs;
 real estate.
Lack of satisfaction with the performance of private equity funds across the industry:
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Oxford Endowment publicly criticizing the private equity industry:
“Why on earth as a rational investor would I allocate blindly to private equity? […] It is a battle to get in:
fundraising, the legal documents with pages and pages of legal jargon designed by lawyers only to be
interpreted by lawyers, the endless legal extensions. And that’s before you’ve even tried to begin
calculating carried interest. […] We need proof that the time and resources required to invest in private
equity is worthwhile. You need to earn your place in our portfolios.”
Sandra Robertson, chief executive of the Oxford Endowment
Source: FT article, 18 October 2012
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The most recent survey by data provider Mergermarket and advisory firm Duff & Phelps
has also shown that over 66% of limited partners are increasingly looking to bypass PE
funds and invest directly in search of better yields and lowering fees. The survey included
interviewing approximately 100 North American and Western European investors.
Source: City AM article, 11 February 2013
Current Industry Landscape
Due Diligence In Practice
A Case Study
Laven Partners
Page. 4
Alternative Investing in the Netherlands
De Nederlandsche Bank’s (“DNB”) research in June 2012 highlighted several considerations with
regards to the alternative investment process and policies of Dutch pension funds;
The research was based on a survey of 35 Dutch pension funds, with each having under EUR 4
billion invested;
Key Findings of the Publication:
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Pension funds in the Netherlands have improved their investment process over the past few
years, however pensions funds’ understanding of the industry does not necessarily match
the complexity of such investment vehicles;
 Many pension funds do not really posses a detailed strategy on alternative investments,
further noting that the additional benefit of such investments is not always adequately
measured and/or justified;
 A few pension funds also lack a systematic and adequate selection process for alternative
investments, with general reporting received by investment managers being below par and
not providing enough insight on risk considerations (amongst other things);
 A clear segregation of duties, tasks and associated responsibilities for the various
stakeholders of the investment process are not documented for a majority of pension funds;
In a statement accompanying the research publication, the DNB noted how important it was that
pension funds start addressing these issues imminently, to better understand and assist in the
development of higher standards.
Source: http://www.europeanpensions.net/
Current Industry Landscape
Due Diligence In Practice
A Case Study
Laven Partners
Page. 5
Key Concepts
Jack Schwager wrote a book on management skills:
“Fascinating insights into the hedge fund traders who consistently outperform the
markets, in their own words From bestselling author, investment expert, and Wall Street
theoretician Jack Schwager comes a behind–the–scenes look at the world of hedge funds,
from fifteen traders who′ve consistently beaten the markets.”
“Hedge fund guru prepares for London float”
By James Quinn, Business Correspondent
source: The Guardian article, 7 April 2007
Since then, nothing on the Market Wizard Fund…
Alphonse Fletcher, who was also profiled in the book “Stock Market Wizards”, is
another fraud currently ongoing in the US since this summer.
Current Industry Landscape
Due Diligence In Practice
A Case Study
Laven Partners
Page. 6
Due Diligence in Practice
Current Industry Landscape
Due Diligence In Practice
A Case Study
Laven Partners
Page. 7
Common Due Diligence Practices
We believe that for many, due diligence is still a tick box approach:
Are the right boxes being ticked?
Are the right questions being asked?
Common due diligence practices are still too focused on the investment side;
Investment due diligence in the absence of operational due diligence is simply insufficient;
We believe that it is the combination of both (Investment Due Diligence (“IDD”) and Operational
Due Diligence (“ODD”)) that allows for the most complete picture of a fund and its operations;
Our approach to Due Diligence is Trust… but Verify!
IDD
Current Industry Landscape
Due Diligence In Practice
ODD
A Case Study
Laven Partners
IPODD
Report
Page. 8
Meeting Best Practice Standards
Due Diligence is not only about detecting frauds, it is also about understanding the internal
operations of an investment company to protect investors from losses which are related to
insufficient operations.
Fraud
Direct Strategy Risks
Lack of Controls/Insufficient Operations
To prevent these risks, we rely on a number of established best practice standards throughout
our due diligence assessments:
Current Industry Landscape
Due Diligence In Practice
A Case Study
Laven Partners
Page. 9
IPODD Report Process
Initial Manager Meetings
Onsite Due diligence:
Initial client meeting to discuss key
deliverables. Introduction to fund
manager.
Deconstruct manager’s DDQ in
our own proprietary DDQ –
understand the fund prior to
going on-site.
Source relevant documentation
25+ documents.
•Meet the manager
•Meet the COO, CFO and risk manager independently
•Cross reference with junior team members
•Walk through the front to back office
•Request a demonstration to support discussions
Review Process
Proprietary DDQs sent to Service
Providers (Administrator, Prime
Broker/Custodian, Auditor).
Discussions with the service
providers.
Communication
Background Checks – including check of all public
records and outsourcing all other personal and
criminal checks to industry leaders.
with
Investor Referees
Perform Laven Partners
Qualitative Due Diligence scoring.
Client Review
Submit Final report to the client.
Current Industry Landscape
Due Diligence In Practice
A Case Study
Meeting or conference call to be
held with the client to analyse final
report.
Laven Partners
Page. 10
In Summary…
Current Industry Landscape
Due Diligence In Practice
A Case Study
Laven Partners
Page. 11
Case Study
Current Industry Landscape
Due Diligence In Practice
A Case Study
Laven Partners
Page. 12
Millennium Global Investments Limited
acted as the advisor (the “Advisor”) to the
Millennium Global Emerging Credit Fund Limited
(the “Fund”)
Current Industry Landscape
Due Diligence In Practice
A Case Study
Laven Partners
Page. 13
The Good Picture
Eye-catching returns:
Source: Fund Newsletter, August 2008
Fund Objective: Long/short credit fund investing in global emerging markets corporate & sovereign
debt, combining the use of derivatives;
August 2008 AUM: USD 811 million;
Reputable Service Providers:
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Administrator: Argonaut;
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Valuation Agent: GlobeOp Financial Services;
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Prime Broker: Credit Suisse;
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Auditor: Deloitte & Touche.
Current Industry Landscape
Due Diligence In Practice
A Case Study
Laven Partners
Page. 14
Michael Balboa’s Background
Before taking on his position at the Advisor, Mr. Balboa was responsible for
research, trade execution and marketing at Rainbow Advisory Services, Ltd.
(“Rainbow”) from 2003 to 2006, an investment advisory firm based in London;
The complaint filed with the Southern District of New York also outlined that, in
or around September 2006, Mr. Balboa applied for a position at the Advisor and
in his application described his role at Rainbow as ‘Fund Manager’;
In marketing material provided to prospective investors of the Fund, Mr. Balboa
Portfolio Manager:
was alleged to highlight Rainbow’s funds’ impressive returns through to 2006,
Mr. Michael Balboa
including a short point describing his previous role with Rainbow as the
“Portfolio Manager”;
It is important to note that Mr. Balboa’s previous ventures (i.e. VZB Partners and Rainbow, where
he was a Managing Director and co-founder of both firms) both seem to have ceased operations
without a clear explanation. This could indicate that Mr. Balboa had previously not been successful
with at least two business ventures;
On 8 November 2006 the Advisor received a Direction from the Financial Services Authority
(“FSA”) requesting a written confirmation from the Advisor “that Mr Michael Balboa has sufficient
technical and regulatory knowledge, skills and expertise as is at least equivalent to the standard
they would have obtained had they passed an appropriate examination.“
Although not an immediate concern, this finding does cast a doubt on Mr. Balboa’s suitability for
the Portfolio Manager’s role. Furthermore, this information was publicly accessible on the FSA’s
website and could have been found by any potential investor exercising thorough due diligence.
Current Industry Landscape
Due Diligence In Practice
A Case Study
Laven Partners
Page. 15
Key Dates
16 October 2008 The Fund is unable to meet margin calls; The Fund’s Directors file “winding-up”
petitions with the Supreme Court of Bermuda;
20 October 2008 The Advisor announces that it is liquidating the Fund; Multiple reports in the
press suggest a person familiar with the situation had implied that this was due to the fact that
some banks had “changed the terms of their credit lines [and] it was no longer possible to execute
transactions”.
21 November 2008 petitions are granted by the Supreme Court of Bermuda for the “winding-up”;
Early 2009 Mr. Michael Balboa leaves the Advisor, and soon after joins asset management
consultants, ARAM Global, taking on the role of Managing Partner;
1 December 2011 Mr. Preet Bharara, the United States Attorney for the Southern District of New
York, and Mr. Ronald J. Verrochio, the Inspector-in-Charge of the New York Office of the U.S. Postal
Inspection Service announce that Mr. Michael Balboa has been arrested;
1 December 2011 On the same day, Mr. Michael Balboa is officially charged with one count of
conspiracy to commit securities fraud and wire fraud, one count of securities fraud and one count
of wire fraud, according to a criminal complaint filed in the U.S. District Court in Manhattan, NY;
A separate but civil lawsuit was also filed by the Securities and Exchange Commission.
Current Industry Landscape
Due Diligence In Practice
A Case Study
Laven Partners
Page. 16
Key Issues
No investment restrictions:
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This was weak for the type of strategy in place;
Other sections of the Offering Memorandum seemed to contradict the fact that there were
no investment restrictions.
Broad leverage disclosures:
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The Offering Memorandum makes reference to the leverage being applicable to the
payment of operational expenses.
Lack of independence at the Fund board level:
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A director from the Millennium Asset Management Limited (the “Manager”) and a director
from the Administrator were included in the 3-member board (the “Directors”);
 The third board member was also on the boards of numerous other funds in Bermuda,
Cayman and the British Virgin Islands.
Valuation risk:
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Language in the Offering Memorandum stated that the Directors reserved the right, at their
discretion, to derogate from the valuation principles specified in the Offering Memorandum.
Although not an uncommon arrangement, considering the lack of independence of the
Fund’s Directors, and accounting for the direct conflict of the Advisor which would benefit
from higher valuations, this would constitute a red flag.
Current Industry Landscape
Due Diligence In Practice
A Case Study
Laven Partners
Page. 17
Valuation Methodologies in Key Documents
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Source: Offering Memorandum
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Source: Audited Financial Statements of the Fund – 31 December 2007
Current Industry Landscape
Due Diligence In Practice
A Case Study
Laven Partners
Page. 18
And what actually happened…
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-
Source: SEC v. Balboa, Case No. 11 Civ 8731 (S.D.N.Y. Filed Dec. 1, 2011)
Current Industry Landscape
Due Diligence In Practice
A Case Study
Laven Partners
Page. 19
Key Findings
Fraudulent scheme to overvalue two illiquid and sizeable securities positions owned by the Fund;
Over the course of 8 months in 2008, 2 ostensibly independent brokers that were enlisted by Mr.
Balboa himself, made “phony mark-to-market quotes” to a valuation agent who inflated monthend prices for Nigerian warrants. The same process was undertaken for providing marks for
Uruguayan value recovery rights over the course of about 6 months during the same period;
The independent brokers were identified as Mr. Gilles De Charsonville, of BCP Securities LLC and
“Broker A”. The valuation agent was GlobeOp Financial Services, Ltd (the “Valuation Agent”).
Mr. Balboa ensured throughout the scheme that the auditor, Deloitte & Touche (Bermuda), Ltd.,
believed the marks were genuine counterparty quotes from an undisputed, independent source;
The marks that were dictated by Mr. Balboa eventually led the Fund to overstate NAV by about
USD 163 million through the 8 months to August 2008, thus generating illicit and inflated
management and performance fees.
Acting in his capacity as the Fund’s portfolio manager, Mr. Balboa received about USD 6.5 million
from the Advisor during the period December 2006 – September 2008. This amount was
effectively a share of the fees the Advisor had collected from the Fund through its inflated NAV.
Current Industry Landscape
Due Diligence In Practice
A Case Study
Laven Partners
Page. 20
Conclusions
Frauds, undoubtedly, are one of the hardest things to detect. However, even in this case, certain
steps undertaken as part of a thorough operational due diligence process, can help mitigate or
better understand the weaknesses and risks prevalent.
For example:
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Check if the Fund was dealing in illiquid and hard-to-value instruments? If yes, the focus of
the due diligence should have been placed on valuation. The fact that 2 small brokers were
the only entities providing the Valuation Agent with prices is an issue.
Check the understanding of the valuation process directly from the Advisor or the Valuation
Agent? Should any of those entities have mentioned that the Advisor was responsible for
providing valuations for a portion of the Fund, this would have immediately raised red flags,
since as the official court complaint notes:
X
Source: SEC v. Balboa, Case No. 11 Civ 8731 (S.D.N.Y. Filed Dec. 1, 2011)
Current Industry Landscape
Due Diligence In Practice
A Case Study
Laven Partners
Page. 21
Balboa’s Fate
Mr. Balboa is very much a free man; On 19 June 2012 a New York judge confirmed that Mr. Balboa
need not wear an ankle monitor any longer and would not be subjected to a curfew.
Mr. Balboa’s attorney, Mr. Joe Tacopina, maintains that his client would be acquitted at trial.
Assistant U.S. Attorney Mr. Christopher LaVigne has stated however that the evidence against Mr.
Balboa “is frankly overwhelming”.
In January 2013, Mr. Balboa founded the Talhuddex Foundation, a family office “with a focus on
long term private investments”;
The ‘About’ section of Talhuddex Foundation’s website even includes a brief biography on Mr.
Balboa, unfortunately missing out the part of him being charged for securities fraud in 2011.

x
Source: http://talhuddex.com/
Current Industry Landscape
Due Diligence In Practice
A Case Study
Laven Partners
Page. 22
Due Diligence Never Stops
Mr. Balboa relaxing…
Current Industry Landscape
Due Diligence In Practice
A Case Study
Laven Partners
Page. 23
Laven Partners
Current Industry Landscape
Due Diligence In Practice
A Case Study
Laven Partners
Page. 24
Laven Partners
Laven Partners is a global consulting firm with a focus on alternative investments.
The company was founded by Jérôme de Lavenère Lussan in 2005.
A team of 30 professionals across six locations – London, Luxembourg, New York,
Singapore, Geneva and Barbados.
Certificate No. FS553272
Recognised industry leader in the alternative assets due diligence field.
Winner of the HFM Week Best Regulatory Advisory Firm Award.
Laven Partner’s process was certified by the internationally recognised ISO
9001:2008 certificate in 2009.
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continues to be audited annually in order to retain this standard;
last audit occurred in September 2012.
World-wide coverage of different alternative asset types and structures.
Our clients include Private Banks, Family Offices, Pension Funds and Fund of Funds.
In June 2012, Laven published the FT Guide to Investing in Funds, authored by
Jérôme de Lavenère Lussan, CEO of Laven Partners. The book is based on Laven
Partners’ unique Independent Process of Operational Due Diligence (IPODD).
Current Industry Landscape
Due Diligence In Practice
A Case Study
Laven Partners
Page. 25
Disclaimer
This material has been prepared by Laven Partners Limited for informational purposes only and should not be construed as legal, tax,
investment or other professional advice. You should consult with your own independent legal, tax, investment and other professional
advisors before taking any action on the basis of this information.
The information provided in the material is based upon sources believed to have been reliable by Laven Partners Limited, but Laven
Partners Limited has not taken any steps to verify the accuracy or completeness of the information. Neither Laven Partners Limited nor
any of its officers, employees, agents, affiliates or advisers make any representation or warranty as to the accuracy or completeness of
the material or are under any obligation, express or implied, to update the information to correct any inaccuracies it may contain or to
reflect any changes that may occur in the future.
No part of this material may be (i) copied, photocopied, or duplicated in any form, by any means or (ii) redistributed, without Laven
Partners Limited 's prior written consent.
© February 2013 Laven Partners Limited
All rights reserved, and all moral rights are asserted and reserved.
Current Industry Landscape
Due Diligence In Practice
A Case Study
Laven Partners
Page. 26
Telephone: +44 (0) 207 838 0010
Email: [email protected]
www.lavenpartners.com
LONDON | LUXEMBOURG | NEW YORK | GENEVA | SINGAPORE | BARBADOS
Laven Advisors LLP (company number OC312558) is authorised and regulated
by the Financial Services Authority with Firm Reference Number 447282.
Certificate No. FS553272