Service Providers: The Importance of Prime Broker Due Diligence
1. Service Providers: The Importance of Prime Broker
Due Diligence
A recent Corgentum study has demonstrated that in the post-Lehman environment investors have
increasingly and somewhat dangerously downgraded the roles of prime brokers. The majority of
those surveyed ranked fund administrators and auditors as being more important than prime
brokers. Specifically, only 17% of those investors surveyed indicated that they felt that prime brokers
were the most important hedge fund service provider.
When investors perform operational due diligence on fund managers, such as hedge funds,
evaluating the fund and firm service providers is a critical element of the process. Included in this list
of service providers should be a fund's prime brokerage relationships.
This survey data suggests a trend whereby investors are increasingly minimizing the roles of prime
brokers. As a result of this minimized importance, resource limited investors run the very real risk of
focusing their due diligence efforts away from prime brokers, and instead on other service providers
which they view as being more important. As the failure of Lehman brothers has demonstrated,
investors can not solely rely on the fact that a prime broker is a big name bank or a leader in the
industry.
Additionally, different fund managers may be receiving different levels of services from prime
brokers. Without delving into the specifics of such relationships, during the due diligence process
investors may not have the information they need to make an effective determination as to the
service provider risks to the hedge funds.
Operational due diligence on prime brokers also provides investors with a useful avenue for
independent fund manager asset verification. Investors who do not even attempt to contact prime
brokers, or who are only confirming a fund manager’s relationships with a prime broker and doing
nothing more, are missing this valuable opportunity.
For those investors that wisely perform evaluations of fund manager prime brokerage relationships
during the operational due diligence process, a word of caution is necessary. Perhaps taking a cue
from the audit industry and on the advice of their legal departments, prime brokers have become
increasingly difficult to deal with.
So for example, if an investor reaches out to a prime broker to ask certain questions regarding the
nature of their relationship with a fund manager, many times prime brokers will send back generic
responses that do not address the investor’s questions in detail. Furthermore, such responses are
often rife with legal disclaimer language making them difficult to evaluate in certain circumstances.
The onus is then put back on investors to follow up with the prime brokers to attempt to have their
specific questions answered. In many cases, prime brokers may be unresponsive or slow to respond
which can