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Investors increase scrutiny of third-party service providers

10th Annual RSM New York Investment Summit


  • Investors increase scrutiny of third-party service providers

As the trend toward outsourcing accounting, IT and other back-office functions continues, investors are looking more closely than ever at how asset managers choose and supervise third-party service providers.

Internal controls and staff continuity were among the top areas of concern in a discussion of operational due diligence at RSM’s 10th annual New York Investment Industry Summit.

Outsourcing helps asset managers focus on investing, but does not relieve them from fiduciary responsibility to monitor the providers they hire, said Greg Farrington, president and co-founder of Constellation Advisers, LLC.

Managers are only as good as their service providers, and there should be no weak links on the team.

Key concerns

In evaluating a third-party service provider, both managers and investors should consider:

  • Sophistication: Is the service provider’s level of sophistication a good match for the complexity of the manager’s investment strategy?
  • Selection process: Were at least two or three other firms considered? Did the manager obtain additional references to supplement those provided by the service provider?
  • Data at risk: What happens if the personal data of investors is lost in a cybersecurity attack on a third-party service provider? How will investors be notified? Is a continuity plan in place? Will insurance cover losses?
  • Key staff: If key people leave the service provider, who will take their place? Will a trainee suddenly be handling the account?
  • Regulatory risk: Are internal and external staffing levels sufficient to ensure regulatory compliance and timely reporting?

Obstacles to investment allocation

While third-party providers can pose risks, so can insufficient personnel and poor internal controls.

When a fund lacks an administrator, investors must dig deeper to understand how cash flows are authorized, how capital that comes in from investors is recorded and whether the movements can be audited.

One promising fund failed to make the cut for an allocation when, during due diligence, it was discovered that the chief financial officer was taking the backup data home every night.

“We can’t be comfortable with this,” said Meredith Jenkins, chief investment officer at Trinity Wall Street, who invests and oversees the fund’s endowments and real estate holdings. “What if he leaves it in a taxi?” 


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