Hedge Funds And Their Auditors – It’s Good To Be Aggressive

Every once and a while someone asks me,

“fm, how do you keep up with all the news, the stories?  How do you know all this stuff?”

Well…Although I have been accused of conceit, presumption, being “too smart,” being too quick to draw conclusions, painting a whole firm black on very little basis, precociousness, general egotistical behavior and, the latest, “sexism, ” I will only concede authoring a blog that publishes often controversial opinions in my own name does require nerve.
And not much of much else.  I read a lot.  I talk a lot.  I listen, but that takes more effort.  I watch news shows and other TV and movies to stay in touch with real life. (LOL)  I read a lot.  I read more. I like to take people to lunch and coffee and pick their brains, push their buttons, get them to drop their masks. Occasionally we have dinner, complete with wine and heavy food. In those instances, I lull them into a mood of complacency and surrender and, before you know it, they tell me secrets.
And every once and a while I read or hear something that causes even me to step back and say to Rosie Rott, “Huh?  What the hell is this, sweety?”
The following press release, from Institutional Investor’s Alpha Magazine Awards event, came in as a Google Alert for Deloitte.
It was one of those, “Huh?” moments.
In Accounting, Rothstein Kass & Co. is the clear favorite among both small and large hedge fund firms. Part of the reason is the firm’s aggressive move to help clients interpret Financial Accounting Standards Board Statement No. 157, or FAS No. 157, the new accounting rule that sets more stringent standards for valuing assets.

BDO Seidman drops one place this year to No.2.

Deloitte Touche Tohmatsu, No. 3 is the highest ranked of the Big Four firms.
1. Who is Rothstein Kass and does the PCAOB know they exist?

2. “…aggressive move to help clients interpret Financial Accounting Standards Board Statement No. 157…” – Aggressive, asset valuation, and accounting in the same press release paragraph on October 24, 2008?  Yikes!
3. BDO, the firm with Damocles’ sword hanging over its head, is the #2 firm for client service to small and large hedge funds?
4. And Deloitte is the #3 firm and #1 amongst the Big 4?  Doesn’t any Big 4 firm, given their audit coverage of other financial services firms present a lot of conflicts?
Hedge funds are, of course, in the news, under much scrutiny, and potentially subject to increased regulation.  There’s concern that large failures in this sector will prevent any economic recovery in the near future and will drag global markets into a doom and gloom scenario that will take forever to recover from.
Even the largest and best firms, such as local Chicago firm Citadel Investments, are fighting off constant rumors of their demise, despite unprecedented prior success.

For the second time in as many weeks, Citadel Investment Group (Note from fm: Not confirmed, but I believe they use PwC) has been forced to deny rumors that it is in serious trouble.

The hedge fund giant, whose flagship fund is down almost 40% this year, denied a Wall Street Journal report that banks were demanding increased collateral as its losses mounted. Gerald Beeson, the firm’s chief operating officer, said Friday that it was meeting its daily collateral requirements with Goldman Sachs, Deutsche Bank, Merrill Lynch and others without being forced to sell its assets to cover the margin calls.

“We will continue to have sufficient capacity to meet our funding needs over the course of the short and medium term,” he said.

And hedge fund results, that is, poor hedge fund results, are throwing many funds a curve ball and stressing their cash positions, forcing frantic asset sales according to some reports.
Hedge funds lost an average 5.52 percent in October, marking their fifth consecutive monthly drop as managers faced sharp stock market swings and angry clients who demanded their money back, new data shows.

The average hedge fund has now lost 15.30 percent in the first 10 months of 2008, putting it in line to post its worst year ever,

Hedge fund managers are sometimes vilified as “shorts. ” Some commentators have turned the words “activist investor” into dirty ones, based on the most active CEOs’ outspoken, blunt assessments of specific company and general economic conditions.

“…Forget about a government bailout—General Motors Corp. would be better off going bankrupt,” according to William Ackman.

During a discussion about the automaker on Charlie Rose Tuesday, Ackman said a “prepackaged bankruptcy” was the best move to get its struggling business back on track.

“The word ‘bankruptcy’ is scary for people, but it is simply a system,” Ackman, head of Pershing Square Capital Management (Note from fm: Uses EY as auditor), said…

In the hedge fund business, you win some and you lose some, as David Einhorn of Greenlight Capital (Note from fm: Uses BDO as auditor) will tell you. It’s just important to win more than you lose over time, as long as it’s not too long a time.

As John Maynard Keynes , the original market interventionist said:

“In the long run, we’re all dead.”
In case you think I’m injecting unsubstantiated, alarming conjecture into this discussion of the potential connection between choice of accountant/auditor and aggressive asset valuations, I will suggest that my idea is not original nor really so outlandish.
The potential for “valuation shopping” and in my mind by necessity “auditor rationalization and blessing shopping” has been mentioned before, in the Financial Times, the Wall Street Journal and academic studies. Surprise, surprise, they say, hedge funds may be “aggressive” and seek out the most favorable valuations for their assets in order to boost performance statistics.
“It is very easy for hedge funds to shop around to find valuations (FM note: And accountants that bless them?) that suit them best and then book their assets at that,” says one banker who advises hedge funds. “Going back to the bank that sold you a CDO and asking for a price is rarely likely to produce an accurate picture.”

Back to the Journal. The story goes on to note, quel surprise, that the hedge fund engage in this sort of behavior to boost performance.

However, caviling aside, there is some new information in the piece, namely, that funds that hold a fair number of positions in illiquid securities appear to seek out favorable valuations to turn months with negative returns into positive results:

Investors should take heed because this massaging can help make the difference between a winning or losing month, the research found…..

So far, investors, auditors and regulators have focused on the way banks and brokers value these securities. But the new research suggests hedge funds may be an even bigger area of concern.

Forgive me for interrupting. The reason regulators haven’t focused on hedge funds is they have no jurisdiction over them…

So, my first step was to go to the PCAOB and look for registration and inspection reports for Rothstein Kass.  If Rothstein Kass is the auditor of choice for hedge funds and, in their words, has, “stepped up and differentiated themselves,” we need to know more about them. Focusing on award-winning client service related to FAS 157, in particular, carries enormous implications. FAS 157 requires hedge funds to divide assets according to liquidity and to document how they estimate the value of assets. The rule also makes it easier for investors to press for more detail than some have traditionally received.
“We’ve recognized — and have for months — that we need to proactively communicate with our clients about [FAS 157],” Howard Altman, co–managing principal in charge of financial services says. “We’re doing that literally every day, to make sure their questions are being answered.”

Rothstein Kass is registered with the PCAOB as of October 31, 2008. When I first checked on October 24th, the PCAOB showed a registration for 2007, also.

Section 102 of the Sarbanes-Oxley Act of 2002 prohibits accounting firms that are not registered with the PCOAB from preparing or issuing audit reports on U.S. public companies and from participating in such audits. With registration comes inspections. It would be helpful to know if Rothstein Kass has been inspected by the PCAOB and if their audit quality, especially with regard to issues related to their hedge fund clients such as FAS 157 valuations, has passed muster with the PCAOB.

Unfortunately, although the Rothstein Kass spokesperson claims that they were inspected by the PCAOB in 2006, there is no inspection report available yet on the PCAOB site. The PCAOB would not confirm that an inspection had ever been performed on Rothstein Kass, since they do not make any information about inspections public until the report is final. Rothstein Kass would not confirm whether their PCAOB inspection report was still in draft, whether it was being reviewed by the firm, or was still in the hands of the PCAOB.

Rothstein Kass did make a Peer Review report that was completed in January of this year available to me. Unfortunately, the Peer Review Report, completed under the auspices of the AICPA’s Center For Public Company Audit Firms Peer Review Program has little value for this discussion. The program allows member firms to choose their own review firm and/or a peer review can be performed by a firm in the the reviewee’s network of firms.
1) The report does not cover accounting and auditing practice applicable for SEC issuers since that is the responsibility of the PCAOB.

2) The report was completed by Richard A. Stalvey, an accountant who is a partner with the firm Fowler, Holley, Rambo, and Stalvey PC , a member firm of AGN International, a network of separate and independent accounting and consulting firms. Fowler, Holley, Rambo, and Stalvey PC is also registered with the PCAOB.

3) Rothstein Kass is also a member of the AGN International Network.

As such, I do not consider this Peer Review to be truly independent or helpful given its limited scope in ascertaining whether Rothstein Kass consistently demonstrates the accounting and auditing practice quality required for being the #1 choice of hedge firms, large and small, public and private.

In addition to BDO Seidman’s issues with regard to their appeal of a judgment in the case of Banco Espiritu Santo which threatens their demise, their most recent PCAOB inspection report had several exceptions noted related to asset valuation and asset impairment decisions. BDO, like Rothsten Kass, is clearly very service oriented to their hedge fund clients and full of folks who’ve gravitated there because they want to work on these specialized topics. Their expertise and influence gets diluted and brushed off in the Big 4. But I think the risks of BDO going under make it a risky choice for hedge funds that are already operating in the risk stratosphere.

Deloitte seems to think they are actually hedge funds’ # 1 choice, based on a read of their press release for the Alpha Awards. I guess, in their mind, the only competition that matters is the rest of the Big 4.

Deloitte today announced it was selected as the top accounting firm in the Alpha Magazine 2008 Alpha AwardsTM by the Hedge Fund 100, Alpha’s most exclusive ranking of the world’s largest single-manager hedge funds. Hedge Fund 100 voters have consistently rated Deloitte as the pre-eminent accounting firm for four consecutive years.

They also tout their expertise in valuation and their consulting practice as a distinct advantage for their clients, even though auditors are not supposed to consult on the valuation and accounting policy decisions of their clients nor supplement accounting expertise that their clients are short of. They are only allowed to audit their client’s assertions.

Deloitte Touche Tohmatsu, No. 3, is the highest ranked of the Big Four firms (Deloitte, KPMG, Ernst & Young and Pricewaterhouse Coopers). New York–based Cary Stier, head of Deloitte’s U.S. asset management services, says FAS No. 157 places a greater onus on hedge funds to produce accurate valuations, a circumstance that puts Deloitte at an advantage over competitors because the firm hasn’t spun off its specialized consulting business, as have some other big firms, Stier believes. “We’ve got a deep capital markets group,” he says. “It also means we have a very extensive financial advisory services group, and they have deep expertise around valuation.

In Deloitte’s most recent PCAOB inspection report, errors in judgement and lapses in quality around valuations also appear a several times, including multiple instances of incorrect accounting treatment for interest rate swaps.

So why would any firm choose Rothstein Kass, BDO, or Deloitte, for example, as their top choice? Well, I think we already know.

They are very aggressive in “client service.”

Here’s another perspective in the words of an attorney who works with hedge funds as an advocate:

“…specialized accounting boutiques have exploited the opportunity to service hedge funds. The Big 4 have significant depth in all that they do (at some level) and they certainly have experience in analyzing complex securities. HOWEVER, their clients are going to be more institutional and less the hedge funds — again because of scale, cost, nimbleness, potential independence conflicts, etc. Hedge funds want aggressive — in everything.”

And from a famous hedge fund executive:

“Historically funds did not use Big-4 because they did not get service and cost twice as much – easier going to a lower-tier audit firm that cared more about you. Because of this, a whole slew of firms became “experts” on auditing funds – BDO, RK and GGK amongst others. This was way before the days of FAS157…”
20 replies
  1. Anonymous
    Anonymous says:

    “Part of the reason is the firm’s aggressive move to help clients interpret Financial Accounting Standards Board Statement No. 157”

    Wow did you ever misinterpret that simple sentence. The firm has made an aggressive move to help clients interpret FAS 157. The firm has not made a move to help clients aggressively interpret FAS 157.

    Twist the words if you want, to make a conclusion that suits your argument. But the sentence as written has but one interpretation.

  2. Francine McKenna
    Francine McKenna says:


    My reaction to the press release was based on the fact that I was not familiar with Rothstein Kass (and felt others may not be either,) they have such a prominent position in this market, and that this press release could be misinterpreted, given the poor choice of words, in my opinion. As I said to their PR professional, I think the press release does them a disservice if they are doing all the right things because it could give the wrong impression.

    If I could have seen a PCAOB inspection report that said they are staying within the boundaries, not helping clients aggressively interpret standards like FAS 157 and not recommending treatment and overstepping their role as auditors, then it would have been a different story.

    At this point, the jury is still out. Suffice to say, the PCAOB inspections of BDO and Deloitte tell us that those two firms made mistakes in this area, whether through neglect or because of their inapprpriate “aggressive” advocacy for their audit clients.

  3. Anonymous
    Anonymous says:


    You state… “Section 102 of the Sarbanes-Oxley Act of 2002 prohibits accounting firms that are not registered with the PCOAB from preparing or issuing audit reports on U.S. public companies and from participating in such audits”

    Hedge funds are not public companies but are structured as private partnerships (LPs or LLCs) and therefore it is not required that their auditor be registered with “Peekaboo” based on your above…so its nice that Rothstein Kass is registered but it wouldn’t be required if they only serviced this types of clients (non-public companies).

    And hedge fund investors care about AUM, and returns and redemption structure and trading strategy -not audit reports. The two big hedge failures – Amaranth and LTCM failed not because of problematic accounting but horrendous trades and trading strategies coupled with piss poor leveraging strategies – these are not symptoms an audit firm would be involved with deciding or even testing (totally out of scope) – it’s up to the traders, quants, etc…an auditor no matter from what firm has no business advising a hedge fund on arbitrage strategy, currency derivative swaps or any other exotic strategy or tool.

    And had Arthur Andersen taken Jim Chanos’ lead with the Big E they would’ve realized something was a wee bit amiss. Therefore, hedgies are sometimes better at analyzing a 10-K than the auditors who prepared, opined and signed off on it!

    — One of Adam Sender’s 247 trading screens

    P.S. Hedge fund investment tip – Priapus Investment Fund, LLC

  4. Francine McKenna
    Francine McKenna says:


    Good point on the public versus private issue. However, some hedge funds are public and some wanted to be like Citadel.

    Some Public Hedge Funds:

    Fortress http://phx.corporate-ir.net/phoenix.zhtml?c=205346&p=irol-irhome

    Blackstone http://www.blackstone.com/

    Och Ziff Capital Management

    Man Group http://www.independent.co.uk/news/business/news/man-shares-plummet-as-global-turmoil-hits-profits-998235.html

    There's also lots of reasons why even "private" hedge funds have external auditors that certify their financial statements. Some have publicly traded debt, or bank loan covenants, or investors that require it. In any event, Rothstein Kass does have audit clients that are public, which is why they are registered with PCAOB. They have to be. One public audit client and you have to be registered.

    And Greenlight, Pershing Square, and Citadel, for example, have large audit firms conducting audits that provide an opinion on their financial statements , althought perhaps not necessarily having to comply with Sarbanes-Oxley.

  5. Anonymous
    Anonymous says:

    I disagree re: Blackstone. Blackstone is Private Equity – I've never heard or known them to think or hold themselves out as a "hedge fund."

    And Greenlight and Einhorny called LEH on their problems – shorted them all the way to the grave…E&Y should've listened…

  6. Oversight for the Better
    Oversight for the Better says:

    Sorry to interrupt, but I have a question. The line that says: “The reason regulators haven’t focused on hedge funds is they have no jurisdiction..” This is fundamental to our economic mess. We(that means all of us, professionals, investors, Joe Plumber, etc.) have committed negligent homicide to our regulatory and oversight duties. So, my question is, assuming we really do have SOME hope for change, is there any group/organization of level heads now existing or that can be formed to serve as a lobby for the public to help shape policies coming out of this mess? Individuals can’t compete with big business. We need to make sure the clean-up is not just a reformulation of more of the same. Thanks for any info you have on this.

  7. Anonymous
    Anonymous says:

    Nice Francine – John Carney is awesome over at Cluster…he is missed at Dealbreaker.

    Meanwhile, some of those testifying saw this mess – John Paulson – called the mortgage mess and made $$$$ for him and his investors because he looked at the real data and didn’t get caught up in the “irrational exuberance.” Or as Mr. Buffet would say Mr. Paulson was not caught swimming naked.

  8. Anonymous
    Anonymous says:

    To touch on the mid size firms advantage, yes I agree, from the standpoint of flexability they are better suited to serve hedge funds since both audit & tax teams work together on the k-1's. Yes before you ask, I'm from a certian big 4 firm which you were from as well and I agree with most of your views on the firm, its no different in the alternative asset mgt group then the group you worked in, I laugh when I read most of your comments becuase eventhough we are in different groups and cities it's the same issues especially when getting stuck between partners from different sides pre-merger…..UGLY!
    All firms are offering a form of 157 guidance to thier clients, but as far as client service it's all about when the k-1's go out to the investors which is a tax not audit service. From the audit side I can confirm most partners are too scared right now to answer the phone these days because most funds have a 45 day deadline for year end redemptions which is friday nov 14th. FAS 157 or not, yearend redemptions=fund liquidations or being gated from withdrawals, which is the most popular appetizer before the main course of liquidation. btw…I could be wrong but I think ggk is now mcgladrey & pullen and imo yes the mid size firms have an advantage because most audit staff work on the k-1's to help get them out the door usually in the same e-mail/mailing of the audited f/s,we don't do it that way and hear the complaining occasionally, especially when our tax bretheren are sitting in the office and were at the client site to get the k-1's out on time which isn't as easy as it sounds in the big4…finally advantage mid size firms!!!

  9. Anonymous
    Anonymous says:

    May I suggest redacting specific hedge fund names, particularly when linked to a “hot tip”, as with anonymous at 11/12 7:45pm. You don’t know where this info is coming from…

  10. Francine McKenna
    Francine McKenna says:


    Thanks for pointing this issue out. I have a policy on the comments: Either I publish or I don’t. I never edit. This is for legal reasons as well as practical, community reasons.

    In particular, when a comment is posted anonymously, readers should be skeptical and never react without doing their own due diligence. This is not an investment or trading site. Nothing that I say about the myriad of clients of the audit firms should be construed as investment advice.

    I will keep a closer eye on this going forward. I’m not going to delete this comment. (I can’t edit it it at this point.) I will remind readers now that the views of the commenters do not reflect my views not do I endorse them. The only opinions I am responsible for are my own.

  11. Anonymous
    Anonymous says:

    Point of clarification…Priapus…it is a real fund but the name – look up what Priapus means from Greek mythology – is very funny and what they focus their investment strategy on is, well, interesting. So the tip may have been a play on words or just a understated joke not an actual investment tip.

    As FM said – do your due diligence which in this case was a 5 second google search.

  12. Anonymous
    Anonymous says:

    Interesting article. And you’re right – the studies and research are garbage. Only two firms are even vaguely in the running – EY and PwC (thanks largely to first mover advantage). Rothstein is good, but only in the US, little presence globally. I would say (as an auditor of hedge funds for over a decade and now a CFO at a hedge fund) that EY are marginally top over PwC. Deloittes really are playing catch up and KPMG seemed to have decided strategically they are not going after that business.

  13. Anonymous
    Anonymous says:

    You have never heard of Rothstein Kass and you are writing a blog about accounting firms??? Lady, you need to get out some more, I don’t have a blog but I am aware of other firms besides the big four…your comments sounded biased to say the least and its a shame you use this blog to trumpet your ignorance. Rothstein Kass was ranked within the top 20 firms nationwide…and anyone that knows the hedge fund industry, would know of the excellent work they perform. To interpret the assistance the offer to their clients in regards to FAS 157 as being other than independent, one would have to have a very unrealistic view of client service and independence. Read a book lady.

  14. Francine McKenna
    Francine McKenna says:

    @4:11: 00

    Then who? I called twice. No response. If not Deloitte, someone from Citadel who reads me every day is sure interested in all the bad news about Deloitte. That’s all the look for when they visit the site.

  15. Anonymoun (for now)
    Anonymoun (for now) says:

    As someone that has made living in the alternative investment auditing business for 25 years I have a couple of points of information. Rothstein is a highly respected firm in the hedge fund industry. There is definately a movement away from “2nd tier” firms to the Big Four with recent scandles but my bet is that Rothstein is doing just fine (McGladrey…not).

    The auditors of Citadel are PwC – out of New York. Anderson were their auditors and the work moved to Deloitte when most of Anderson joined Deloitte. The work then went out to bid and landed with PwC.

Trackbacks & Pingbacks

  1. […] technical talent. Most prefer to work in a smaller firm where they can really shine.  A firm like Rothstein Kass, a medium size east coast firm that specializes in hedge funds, is a good example.  Another is SAS […]

  2. […] In the meantime, they did settle Parmalat, but now they’re named in several suits related to the Merrill Lynch acquisition by Bank of America and the Bear Stearns failure.  Deloitte is the only Big 4 firm to have escaped any Madoff feeder fund exposure even though they are supposedly the number one choice of hedge funds. […]

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