American Realty Advisors: Alignment Of Interest

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Alignment Of Interest -

Lessons From Alternative Investment Transactions:
What You See May Not Always Be What You Get

By Stanley L. Iezman

When an institutional real estate investment goes bad, institutional investors are not very different from the average retail investor who in the 1980’s bought real estate syndications which were motivated by tax considerations rather than economics. When those investments failed, these investors were quick to point fingers and find fault with a variety of different factors surrounding the investment, all of which seemed to focus on issues extraneous to the underlying investment, rather than issues pertinent to why the investment failed. The typical "mom and pop" investor wants to believe that the operator or offeror is a crook or that the market was manipulated by others more knowledgeable or powerful than them. The institutional investor on the other hand, is much more sophisticated and tends to cloak those same statements in more eloquent words which draw upon the lexicon of Wall Street and seeks to find a more lofty explanation for the problem.

Much has been written and talked about over the last four years concerning the reasons for the apparent real estate debacle in the institutional world in the late 1980’s and early 1990’s. The answer, according to much of the popular press, the CIO’s of the major pension plans, as well as the consulting world, appears to reside in many factors including that the proper "alignment of interest" of the investment manager and the investor apparently did not exist.

Most everyone who performed autopsies of those soured investments have concluded that with several twists of the dial the alignment of the parties can be more effectively accomplished and that the problems which we experienced in the past may be resolved and not be repeated. This has not been lost on all of those who are involved in investments and the "mantra de jour" for most who are seeking to invest in real estate, be it manager, investor, or CIO is the new language of alignment of interests. Alignment of interests has become the emperor, and the emperor may have no clothes! A bad investment is a bad investment and a good investment is a good investment, irrespective of the alignment of interest of the parties. The focus of the institutional investor has been to seek a structure which provides a solution to many of the problems they previously experienced and to otherwise restructure many of the aspects of the investment vehicle to ensure that the investment manager is properly incentivized to produce returns consistent with the investment strategy.

The purpose of this discussion is to examine the various ways in which the parties’ interests can be arguable aligned and how that alignment of interests may or may not impact the ultimate performance of the investment. We would also like to put into perspective the fact that the investor should not simply rely upon the manner in which the parties perceive that the alignment of the interests is accomplished as being of any significant value to the determination of performance, as the alignment of interest is only one issue to consider among many when making an investment.

No one can protect us from unscrupulous or dishonest managers, officers, directors or promoters and no one can develop a checklist or a test which can ensure positive investment returns. What we do know, however, is that investors who understand the role of fiduciary process and implement an investment program based upon that process will generally find themselves achieving above average returns, in part because the utilization of a process driven matrix will eliminate or allow the investor to understand a great many of the risks inherent in creating a viable investment program.

We also want to place in perspective that investment managers who are fiduciaries have significantly higher responsibilities, when developing a real estate investment program, than the average real estate entrepreneur or developer who will and can take significantly more risk and is not subject to the same standard of care. The appropriate structure of a transaction is designed to protect various interests within the investment but engineering the structure does not guarantee nor does it substantially impact investment results. The plan sponsor with their investment manager must address those interests carefully and the primary focus should be on the viability of the strategy and the ability of whoever is hired to implement the strategy, rather than simply on the structure.

Investment Strategy

The goal of any investment by a pension plan is to produce returns to the its investor, necessary to provide benefits to the annuitants of the pension plan. The key, of course, to any viable investment program is to: (i) properly identify the investment strategy that the pension plan would like to undertake; (ii) to otherwise identify the appropriate investment manager to implement the desired investment strategy; and (iii) set up a system to properly monitor the adherence to the strategy, the results of the investment and the efforts of the investment manager.

Many articles have been written and many consultants’ reports have discussed the way in which appropriate investment strategies should be implemented, as well as the proper and appropriate methodology for selecting the investment manager necessary to implement the investment strategy. Unfortunately, a great deal of focus has been on the plan sponsors’ desire to uncover attractive investment strategies and not on the ability of the investment manager to implement the investment strategy itself or to otherwise impose safeguards to ensure that the manager is implementing the investment strategy properly through a careful monitoring program.

Investment strategies are like buses, as my mother often said: "One comes along every five minutes." The popular investment strategy or the "strategy de jour" may not necessarily be a viable investment strategy, but it may attract a lot of public, private and press attention as a result of the fact that it appears as if it can achieve a significant return. Every day we read about the "hot" stock or the "hot" mutual fund, or the "hot" real estate market in the plethora of publications which tend to publish those type of articles. Every day we see real estate investment managers develop investment strategies which may have more of a marketing bent to them, and which are designed to appeal to what the investor wants, but which may be at best a naive belief that what the lemmings follow will provide an attractive return. Now, we are not suggesting that what the investor wants should be ignored. Rather, every bit of attention of an investment manager should be directed to understanding what the client wants and how to deliver what they want to them. It is the purpose of this conversation to suggest however, that too little attention is focused upon the investment strategy, the monitoring process and the ability of the manager to produce returns, rather than on structuring issues.

Inasmuch as this discussion is going to be focused on real estate, and not alternative investments or other asset classes, we will seek to draw from the experiences of those various investment structures and to overlay them upon the world of real estate. The alignment of interests of the investor and the manager draws its strength from the fundamental belief which we all learned from Investments 101 that all parties must be motivated to work to accomplish coordinated and mutually agreed upon goals which are in everyone’s interest. The real estate universe, however, has historically been a private market and has looked to the public market as well as the venture capital world to find its voice within the cacophony of alignment of interest.

Now let us look at the many ways in which institutional investors have focused on structure as a way of addressing the problems. Initially, it must be pointed out that in the public real estate market an investor dissatisfied with the specific investment returns or the management of an entity, or just wanting to exit its investment, arguably can liquidate their investment when they want to and walk away from the investment either with a gain or a loss. The greater the control over the entity, the more difficult it becomes to liquidate both the investment and the investor’s obligation to the other co-owners (an investor who is in control owes certain obligations to its co-investors). When one has the same desire to liquidate a private real estate investment it becomes increasingly more difficult to do so, depending upon the structure of the investment. If the entity is a commingled vehicle, be it a corporation, limited partnership, limited liability company, or a joint venture, liquidation of the investment is difficult, because there is no viable secondary market for the interests of such an investment.

If the entity is in the format of a separate account, e.g., an operating entity which is controlled 100% by an investor, the investor can terminate the existing manager or management team and hire a new manager or the investor can order a liquidation of the underlying assets. This control element is crucial to the investment process surrounding liquidity. In the private market liquidation becomes more costly and takes more time. Still, it must be pointed out that liquidity in a real estate public market vehicle may be much easier than a private market vehicle. Whether the interests of the parties are aligned or not, it is clear that the issue becomes much more relevant and sharper in the private market because of the very real issue of lack of liquidity.

The primary focus for most institutional investors to find the proper alignment of interests of the parties is to look at the following key issues:

Accountability: Accountability occurs by developing a management team which is exclusively dedicated to the management of that account’s assets and to no others. This can occur within a single and exclusive investment structure or on an exclusive management basis.
Co-Investment: Proponents of co-investment state that having the investment manager invest a significant portion of his net worth in the investment provides assurance that the investment manager is working in the investor’s best interest because he is working in his own best interest.
Fee Structure: The focus upon the fee structure is upon developing one which properly incentivizes the manager to provide superior returns by ensuring that the manager wins if the investor wins and the manager loses if the investor loses.
Exclusive Investment Structure: The focus here is to develop an ownership structure requiring the manager to only manage the investment vehicle in question and no other, so that the management team is focused only upon creating value for that entity, versus having their time diverted to other businesses, e.g., multiple entities and clients or investment vehicles.

Let us now look in more depth at the various ways in which we all seek to align the interests of the investment manager and the investor:

Accountability

The goal of the investor is to gain accountability from the manager and to ensure that the objectives of the pension fund investor are being met at every stage of the investment process. We can spend a great deal of time focusing on all the ways that corporate management can take advantage of shareholders through excessive compensation, stock options, corporate perquisites, corporate opportunities and the like. In fact, many major public pension plans expend a great deal of time and energy motivating corporate management to act in the best interests of the shareholders. In addition, much attention is focused on excessive executive compensation and how corporate investors should find ways to reduce it or tie it to the overall company performance. Objectivity in evaluating the management team and accountability of the team is the cornerstone for most of these discussions.

Accountability, however, is in the eye of the beholder. Is $90 million paid by a major public company as a severance package to its president terminated after 18 months of service, in the best interests of the investor? Or is a $600 million incentive stock option plan for the Chief Executive Officer of the same company in the best interest of shareholders . The same investors who criticize real estate investment managers because of lack of alignment of interest show up at the board meetings to shake the hands of those two people because they are perceived to have the interests of the investor properly aligned with theirs. Yet, the investor’s net worth or net investment value never increased proportionately to the increase in the net worth of these two individuals.

What is very important to point out to the institutional investor is that investing in an operating company has significant advantages for those who understand the risk and concomitant obligation to monitor that investment. Operating company managers are not fiduciaries, they are corporate managers subject to corporate laws or similar laws. They serve the shareholder/investor, that is clear, but what is not as clear is the level of risk they are or may be undertaking and what obligation they have to the pension investor.

Real estate investment managers who are fiduciaries must act in a manner which is slightly different than the corporate/venture capital entrepreneur. Risk and growth are key to the venture capital operator while the traditional investment manager typically does not undertake that risk, unless clearly identified within the investment strategy. Thus, when investing in a sole investment structure which has been defined as an operating company, the investor must understand the risks of the investment and what management and control risk they are willing to take.

The alternative arrangement which has been suggested by some is to develop an exclusive relationship with a management team within the offices of the investment manager. This arrangement arguably serves the goal of accountability. The team which consists of all major decision makers can work on no other investments and are dedicated to that client.

This raises many interesting questions. Even assuming you are getting the "A" team within the manager, the question arises as to how you deal with other clients of the same manager who arguably got the "B" team or what do you do to motivate the team individuals when this account is stagnant or declining, or how do you simply cope with a desire of someone to move on to other challenges either inside or outside the organization. Further, how do you terminate an exclusive relationship with a management team? What happens if the investor wants to roll up the investment team into a public vehicle? What fiduciary or legal responsibilities are owed the investment manager by the investor? The exclusive relationship will not produce superior returns; rather superior returns come from superior management and a desire to profit from providing superior returns. Accountability should fall more clearly on the shoulders of the investor. The investor in any investment must determine whether management is doing its job - if not, they should be fired.

Co-Investment: The rationale for the co-investment model starts with three propositions:

The investment manager who has not invested its own funds pari passu with the investor is going to do a less substantial job of managing the investment than one who has;
The investment manager who has its own funds invested side-by-side with the investor will be more concerned about generating a return than one who has not invested its own funds; and
The investor who co-invests its own funds would not otherwise make the investment if the manager did not believe that the investment made economic sense.

All of the above presumes that the presence of co-investment stimulates behavior different than the absence of co-investment. This argument fails to identify the fact that managers who co-invest make mistakes; the same mistakes that everyone makes, whether they made a co-investment or not.

If this was not the case, how does one explain 90% of the lenders in the United States borrowing short and lending long in the 1970’s and 1980’s. Or, how does one explain the many large real estate companies of the 1980’s putting their own money at risk to make investments, on a co-investment basis, with their lender, all of which underperformed everyone’s expectations. Other people’s money or "OPM," as we like to affectionately call it is still "OPM," whether it is debt or equity. The only difference is that with debt the investor/lender winds up with the assets following foreclosure of a bad investment while the equity co-investor has no recourse but to live with its new partners.

Co-investment has been around since Cro-Magnon man began to lend tools in exchange for food. The banking and lending industry is grounded on co-investment, and that has in no way produced results better than without co-investment. Co-investment by lenders has traditionally focused upon capital flows and risk. The more money a lender has to lend the more risk it is willing to assume. Thus, to put this into the context of co-investment, the lower the amount of the co-investment, the greater the risk. Conversely the higher the co-investment the lower the risk. Co-investment, again, is only co-investment. It only creates a different relationship between investor and manager not simply an incentive to perform.

Investors should certainly look at all aspects of the investment, but as stated earlier, a bad investment does not become better because an investment manager co-invests its own capital. Co-investment may have more of an emotional appeal to an investor and have more a placebo like effect than otherwise realized.

Now let us at least identify the conflicts of interests which exist with the co-investment structure. Conflicts of interest are important issues which we all need to identify when structuring an investment. The co-investment option is fraught with conflicts of interest which are traps for the unwary. The powerful argument stated earlier is that the manager will be more focused if he has invested his funds side by side with his client. Clearly, the typical high net worth investor feels more comfortable knowing that his or hers’ investment manager is sweating along side to achieve a profit. The issue is not easy to solve when the goal of the manager may be different than the investors. The timing of the disposition of the investment may change depending upon the capital expectations or goals of the money partnered investment manager. Should the investment require additional capital, which at that time the money partner does not have, the investment decision may be based on non investment related concerns rather than the best interest of the investor.

What happens when the money partner wants to liquidate its investment and seek other investment options outside of this area? Again, the decisions made may be subject to more bias than otherwise realized. Further, how do we deal with risk? The courts of America are filled with lawsuits of partners and co-investors who are seeking to enforce buy/sell provisions or put call options, all of which were carefully drafted with the goal of developing a viable structure.

Fee Structure

Let us now examine how fee structures are being designed to ensure that the parties’ interests are properly aligned. The initial thought is that if a fee structure is based solely on performance, the investment manager succeeds if the investment succeeds. Thus, back ended fees, incentive fees, and lower front end fees are all designed to accomplish these goals. It is important to point out at this juncture that this argument comes from the venture capital world. In this world, start up companies with incredibly good but risky ideas, are developed by individuals with little financial capital but a great deal of intellectual capital. The money partner or investor who makes the initial or mezzanine investment to take the company into the next phase of its growth has hurdle rates of 25-40% per annum and expects that its investment will be handsomely rewarded with the company going public IF the product or idea proves viable.

Risk is understood up front. The non money partner understands that in exchange for this capital that they will work for much lower pay than they would otherwise receive if they were working in a world with little or no risk, but with the opportunity, as well, to share in the rewards IF the product or idea proves viable. That is the foundation of capitalism. The management teams of these start ups, for the most part, have good ideas or strong intellectual capital, but they are generally not good managers or communicators. They lack financial capital or the management strengths to capitalize on those ideas. There are those rare exceptions, but the roads of the silicon valley are paved with the heads of many wealthy entrepreneurs who had no idea how to run a company, be it public or private.

Once the company becomes viable with a proven management team capable of taking the idea to market, then the entire compensation and financial structure changes radically. Compensation is now a market based system, with rewards coming from growth in the overall company’s value. This model is an excellent one and works very well for that type of a market. But real estate arguably is much more of a structured asset where management, systems, communication, knowledge and the ability to operate the investment requires more skill than a good idea coming to market. The good idea requires skill, but a skill which is not a commodity like real estate.

Now, we are not saying that investment management capabilities are commodities, but they require far less sophistication than developing the new technology which allows me to type this article from home on a computer and send it via a modem over a telephone wire, (and soon through the air waves) to my office where my secretary will be able to format it properly.

Thus a fee structure for the world of core real estate becomes much more difficult to back end. Performance is too difficult to monitor. A fee structure which looks to performance in this area cannot be appropriately segmented between manager rather than market performance. As we go further out on the risk spectrum, than fees arguable can take on a more entrepreneurial flavor where a portion of the fees can come from performance.

The unfortunate part of this discussion is that investors focus much more on fees within the real estate investment management world then they do on incentive compensation for all of the various companies which they own directly through their stock managers. Real estate, because of its emotional and physical state, results in all of us thinking that because we see it and feel it and can touch it that we have more interest and knowledge about it. This results in most investors being more interested in a clean parking lot rather than the cash flow that is being generated from the asset. The thinking being, of course, that the clean parking lot will produce even higher returns. There is nothing wrong with that thinking, but it oftentimes results in investors thinking that they know a lot more about investment results than they know. Thus fees become the carrot to motivate results, rather than results being properly rewarded.

It must be suggested at this juncture that intellectual capital, which is found in the investment managers, is like financial capital in that it will flow into capital constrained markets, as that will result in the highest yield to the holder of that capital, if the market in which that capital operates is not producing high returns. In essence as long as fees are pushed down, the investment manager who agrees to take such a fee will only deliver what he is being paid to deliver. He may not be able to provide the intellectual capital to make completely sound decisions when he is not being paid to make sound decisions and the type of decision that will be made will more akin to the type of decisions that are made by those who are in more of a commodity business. The result may look more like the mean.

Performance fees, as well, must be viewed within the context of ERISA. ERISA has imposed some very high hurdles on fiduciaries as it pertains to fees. Clearly our lawmakers understand a very important maxim: to wit, that an investment manager should not be in control of the timing or the amount of the fee.

Often, however, such a fee structure shifts to the fiduciary not only the risk of his own abuse of power, but also the risk of events beyond its control. For example, an investment manager has no control of whether the market goes up or down, but rather he understands whether the market is going up and down. If a performance based fee shifts the risks of events beyond his control to the fiduciary, he may decline to take the risk.

Performance based fees also produce undesirable incentives. When the fiduciary’s fees are measured as a percentage of the gains without regard to losses, the fiduciary may risk an investment to increase his fee. Moreover, as long as the benefits from its use can be hidden, performance fees do not create an incentive for the fiduciary not to profit from the relation, or otherwise misuse delegated power. Therefore, fee structures provide only a partial solution to the problem and raise other problems as well.

Fiduciary Responsibilities

We need to focus briefly on the issue of fiduciary responsibilities within the context of real estate. We can not overstate the importance of juxtaposing corporate with fiduciary responsibilities. The traditional real estate investment structure, developed over the last twenty years in the institutional world, has been an investment by a pension plan in a commingled fund, or in a separate account, with a manager authorized within given parameters to make investments, manage cash, implement a defined strategy, etc. Likewise, in the stock market, various commingled vehicles possesses certain key operational characteristics which have served investors well over the years. These are:

centralized management;
continuity of life; and
limited liability

Trustees of pension plans have for many years made investments in corporate entities which exhibit those characteristics. It must be pointed out that fiduciary responsibilities under ERISA and under corporate law are not the same. The ERISA standards are higher and while corporate responsibilities are important they do not have the same level of concern as that imposed on ERISA or ERISA like fiduciaries.

ERISA Fiduciary Responsibilities

It is extremely important to point out in discussing this topic that an investment manager is a fiduciary under ERISA as to those pension plans which are governed by ERISA. The standard of care imposed upon a fiduciary is a higher standard of care than that imposed by law, or otherwise on anyone acting in any other capacity, including that of an officer or director of a public or private company. This is an important nexus to the focus of this discussion inasmuch as a plan fiduciary must discharge his duties solely in the interest of the plan participants and beneficiaries and for the exclusive purpose of providing benefits to participants and beneficiaries and defraying responsible administrative expenses of the plan. This very high standard should not be lost upon pension plan trustees and investment officers.

It is this rule that imposes the prudent standard which is the most fundamental rule governing the conduct of plan fiduciaries. The prudent standard requires that a fiduciary discharge his duties with the:

care;
skill;
prudence; and
diligence;

under circumstances then prevailing that prudent persons acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of like character and like gains.

ERISA has set out that the prudent person acting in a like capacity and familiar with such matters is generally believed to mean that a fiduciary must act as an "expert" in the area.

A plethora of case law and regulation created under ERISA sets forth the standards to be imposed on plan fiduciaries, all of which implies both directly and indirectly that a fiduciary has significant responsibilities which are greater than that imposed by common law, or under corporate law.

The prohibited transaction provisions involving conflicts of interest, the parties-in interest rules and all of the other provisions involving ERISA are fairly explicit and encompass many more pages in the federal register than any corporate law that currently exists.

While public pension plans are not subject to ERISA, there are fiduciary standards that apply to many public retirement systems. In California, for example, the major public retirement systems are subject to a prudent person standard with respect to investment and diversification requirements similar to ERISA as imposed by the California Constitution, Article XVI, Section 17, and must place their duties to participants and beneficiaries in precedents over any other duty.

The California Constitution goes on to state that a fiduciary of the public pension fund or retirement system shall discharge his or her duties with respect to the system solely in the interest of the plan beneficiaries, and for the exclusive purpose of providing benefits to participants and their beneficiaries, minimizing employer contributions thereto and defraying reasonable expenses of administrating the system.

In general, each type of public retirement system is governed by a separate statutory scheme, although some overlapping does exist. Consequently, unlike the case of ERISA regulated plans, the nature and extent of investment authority of a fiduciary with respect to a public system may vary among states and often even within a single state, but the fiduciary standards typically are applicable.

The primary objective of an investment manager who is a fiduciary and the investment to whom authority to act as a fiduciary has been delegated is to preserve principal, while receiving a reasonable amount of income, rather than to take risks for the purpose of increasing the principal or income, absent a specific mandate to do so.

The real estate investment management business does not have a significant number of firms offering services similar to the number of investment banks, both on a national, international and regional basis, or the number of corporations or operating companies who pension plans can invest with. There is a very significant reason for that, and it all surrounds the issue of the fiduciary duties imposed upon investment managers, which most people do not want to undertake. Investment bankers, lawyers, accountants and many of the other professionals involved in creating investment guidelines and providing investment services to pension plans, all want to ensure that they do not assume fiduciary responsibility or that that they have a fiduciary relationship with the investor. There is a great deal of effort that is given to the parties to ensure that no fiduciary relationship exists.

Corporate Fiduciary Responsibilities

Generally, the board of directors of a corporation has the sole responsibility to manage the business and affairs of a corporation with the concomitant fiduciary obligation to protect the corporation and act in its and its shareholders best interests. The directors of a corporation have three fundamental duties to the corporation and to its shareholders: care, loyalty and good faith.

Public policies establish demands upon corporate officers and directors to ensure that they are scrupulous in their observance of this duty.

This is not only to protect the interest of the corporation committed to their charge, but also to prevent them from doing anything that would invoke injury to the corporation, or would deprive it of profit or advantage which their skill and ability should properly bring to it.

The issue that must be clarified is the extent to which a member of a board of directors or an officer is held to a different standard of care than a fiduciary under ERISA. When a shareholder challenges a board decision two fundamental questions typically shape the controversy. First, the court must determine how closely it will scrutinize the board’s decision. This is frequently referred to as the standard of review. Second, the court must decide which party, the challenger or the board, will have the burden of proof with respect to the issues involved in reviewing the board’s decision.

In response to these concerns courts have developed a doctrine known as the Business Judgment Rule to give boards of directors significant protection and discretion in the making of business decisions. The Business Judgment Rule provides the starting point for the appropriate standard of review and burden of proof in cases in which a shareholder challenges the board’s business decisions.

The courts have frequently stated that the Business Judgment Rule is a presumption that in making a business decision, the directors of a corporation acted on an informed basis, e.g., with due care, in good faith and in the honest belief that the action taken was in the best interest of the company. In most legal challenges, the court initially presumes that the board fulfilled all of its fiduciary duties when it made the decision.

At this juncture, let us review what a corporate fiduciary obligation is. If a person in a particular relationship with another is subject to a fiduciary obligation, that person (the fiduciary) must be loyal to the interest of the other person (the beneficiary). Fiduciary duties go beyond mere fairness and honesty: they oblige the fiduciary to further the beneficiary’s best interest. A fiduciary must avoid acts to put his interest and conflicts with the beneficiary’s. For example, if the fiduciary contracts with the beneficiary, the contract is voidable by the beneficiary unless the fiduciary discloses interest adequately under the circumstances. If the fiduciary benefits or acts inconsistent with his obligation of fidelity, the beneficiary can recover any benefit realized by the fiduciary unless he consents to the fiduciary’s retention of it. In transactions between the fiduciary and beneficiary, therefore, the fiduciary must be candid and exercise the highest standards of care in the utmost of good faith.

There is an inherent risk involving any relationship between the two parties. The ability of a board of directors, as well as an investment manager who is a fiduciary, to misuse the power entrusted to him or her to the detriment of the beneficiary is tantamount to every relationship. It is inherent in all relationships. The protective mechanisms outside of the fiduciary laws can not adequately eliminate this risk. The risk of abuse, which all fiduciary relationships pose must be understood.

The historical failures of real estate transactions in the 1980’s did not arise from malice or desire to take advantage of the beneficiary. Rather, they stemmed from a variety of factors including market factors, structural factors, fiduciary responsibilities, and other controllable or non-controllable systemic and non-systemic factors.

The fundamental breaches of fiduciary duties which include:

abuse of power; and
conflicts of interest;

do not necessarily arise or are avoided as a result of realigning the interests of the parties. The proper alignment of interest to the parties stems from the fact that the investor must do the following to better protect its interest:

using only fiduciaries who have no conflict of interest with the beneficiaries;
inducing fiduciaries to refrain from abuse of power by appropriate rewards;
imposing controls upon fiduciaries;
monitoring fiduciaries; and
using common sense to control fiduciaries.

Conclusion

Every investor is justified in expressing anger and concern over a failed investment. Seeking new ways in which to ensure accountability and control over their investments is desirable and admirable and recommended in EVERY case. The issue of accountability and control through the proper alignment of interests, as has been articulated over the last four years, may be more of an attempt to find emotional rather than structural solace. No structure, nor corporate or partner control, can be created to solve the problem of an unlawful or deceitful investment manager, nor can an investor develop a litmus test which will determine incompetence within a management strategy or team. Structuring an investment with all of these controls in place only means that we have spent a great deal of time structuring the investment. The question of whether the investment strategy is compelling or whether the management team can implement it must be done up front, before the investment is made. Once a decision is made, the normal legal controls should govern and there should be much more reliance on monitoring the investment team to verify that the investment is performing. Passive reliance on legal or structural documentation will never replace the diligent oversight that every CIO owes as a fiduciary to its pension fund. This active development of an investment strategy, monitoring of the manager and oversight at every level will generally provide very high risk adjusted returns. This oversight should never be confused with looking at the alignment of interests of the parties. Both play a role in results, but the oversight will generally result in better yields.