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Finomial Corporation today highlighted the role of the Finomial Investor Services Compliance Platform in protecting hedge funds from the risks highlighted by the Panama Papers leak. While the media focus to date has been on the law firm’s role (Mossack Fonseca) in creating shell entities (which in many cases are legal), Finomial protects hedge funds from the risk of unwitting acceptance by the investment management community of money from entities with unknown beneficial owners.
Hedge Funds are vulnerable to unintentionally accepting investments from entities with anodyne names and obscured beneficial owners. A shell entity’s capital can be accepted by a hedge fund, theoretically, only once it has undergone a rigorous - yet entirely manual - process. Unfortunately, the value of a rigorous review of investment funds is entirely in conflict with the reality of the ground - manual, opaque investment processing, which is difficult to manage, monitor and audit.
Much of the burden for uncovering potential unlawful investment activity falls on the asset servicers - the fund administrators. They are tasked with an almost impossible responsibility for scrutinizing the documents that are required from hedge fund investors. The fund administrators who are processing money from these entities on behalf of hedge funds have difficulty looking through to these beneficial owners. It is only through rigorous review of paper documentation and a series of offline requests that they might have the opportunity to discover a true beneficial owner, or an inconsistency or a red flag.
The intensely manual nature of investing in hedge funds puts inordinate burden on the hedge fund managers and fund administrators. Unlike the rest of the financial markets, there is no transparent, electronic processing of alternative investment documentation.
Today, entry into a hedge fund requires the investor - the investing entity - to complete a subscription agreement. These agreements are in large part designed to elicit sufficient information and representations from investors to protect hedge funds from accepting questionable investors.
Combing through subscription agreements and supporting documentation to determine beneficial ownership and to identify potential indications of tax evasion (as required by the FATCA regulations) is nearly insurmountable. Fund administrators and hedge funds tackle this task with diligence and documented “processes and procedures,” yet the manual email driven nature of processing these transactions means it is subject to human error, and it is anything but transparent. Fund managers would like to have visibility to the documents and be able to review their work, but with PDFs and spreadsheets sent via email, there is no single place to systematically review and track the investor compliance process.
Said Meredith Moss Finomial CEO: “What is required moving forward is an automated electronic process to secure greater assurance that compliance requirements are met. The Panama Papers highlight the global jurisdictional reporting of and accounting for individuals who are subject to tax. Regulators and legislators have, beginning with US and UK FATCA regimes and now with OECD CRS developed rules and mechanisms to broaden their reach and systematically capture and report on responsible parties for tax purposes. This regulatory burden will only continue as regulators worldwide have called for increases around tax regulation. As a result, given the complexity and scope of the tasks involved, automated electronic processes will be essential for operations groups to be certain they are in compliance. Otherwise, they are at risk of becoming overwhelmed by the sheer volume of work involved and the attendant risks for errors, which may be subject to enforcement actions.”
