Where are the Risk Auditors?

As Roger Lowenstein says, Ezra Merkin was (is?) "a Wall Street sage, noted philanthropist and professional money manager". And yet for all his protestations that he was risk-conscious and diversified and an expert at due diligence, he still ended up simply investing substantially all of many of his investors' funds with Bernie Madoff.

This is the really invidious lesson of the Madoff mess: not that some fund managers are crooks, but rather that there is no way of knowing whether the non-crook fund and fund-of-funds managers are being entirely honest when they talk great game about their risk controls.

It strikes me that there is, or should be, serious demand for a trustworthy and reliable auditor who can check up on such claims. If I were running a hedge fund or fund-of-funds with elaborate and expensive and effective risk controls, I'd be eager to pay such an auditor a relatively modest sum to be able to distinguish myself from the frauds who talk a great game but who in reality do nothing. Even banks might avail themselves of such a service, in an attempt to persuade investors that they really have reduced their tail risks.

What's more, the existence of such an auditor might well do a good job in empowering professional risk managers, who tend during good times to get overruled by superiors who are strongly incentivized to make money rather than minimize risk. "If you go ahead and do this," they could say, "we'll lose our A+ rating from Risk Auditors Ltd".

Of course, anybody setting themselves up as such an auditor would need impeccable credentials when it comes to measuring risk in practice, and keeping proprietary secrets. Is there anybody out there who fits the bill?

Comments

[Lars39:]

Where were the Boards of Directors of companies such as AIG, Lehman Brothers, Bear Sterns Wamu, etc, etc, leading up to the financial meltdown caused by subprime, derivatives and similar sure fire get rich quick corporate endeavors?
Hard to believe these companies didn't see the risk they were taking relative to the giant bubble forming.

Jan 13 05:42 PM

[buyitcheap:]

Felix, Felix, Felix... your governance naivete is at once refreshing and disturbing. Do you really think that anyone in the C Suite listens or is barely more than aware that they have auditors? Internal or otherwise?

Auditors get NO time of import in front of the board. Yet the best practices of governance highlight a private session were inept board members can ask any question they want.

FACT: US Corporate governance is completely broken. It is more common for the head of the Audit committee to meet with the CFO than to meet with their representative - the Director of Audit, or Chief Risk Officer. (Example: We (the internal audit group) just had our quarterly meeting. Well, actually it took place without us. We (the audit department on the East Coast) were informed Monday, of the Audit Committee meeting on Wednesday in Palo Alto. The CFO would be presenting. When the CFO runs the meetings, governance is over. He/she can say whatever the hell he/she wants.

So don't waste your time on risk auditors, auditors of any kind. This financial debacle is 100% the creation of the CFO, the CEO, and the blind, dumb, and impotent board members.

Jan 13 07:31 PM

[Seen All It...:]

Do you mean those pencil neck geeks that get in the way of doing a deal? The risk people are never consulted by the new product developers or sales managers, they only put limitations and caps on potential income. Risk people are pushed out the door because they try to stop the train or hit that magic age of 50. Project managers know not to include risk people in conversions, because they just slow the process down. But then no one ever listens to any warnings based on a risk auditor's experience because history never repeats itself.

Jan 13 11:05 PM

[Steven Hansen:]

there is no way for an audit system to be effective.

one undertaking i was involved with had insurance, government, corporate, and external auditors. we were judged clean - each were shown a different set of records.

finally, the external auditor who had his head screwed on straight said he was giving us a clean bill - but he said it was impossible that we could have passed this divergent group of auditors. he wanted to know the secret off of the record .... we just smiled.

my point is that it is impossible for an non-embedded auditor to discover the truth when you have a determined group which wants a particular outcome. it is unlikely that an embedded auditor who is part of the paper trail can be fooled (but he can become part of the conspiracy).

Jan 14 12:43 AM

[MarvinMBA:]

Some things in this world should be a matter of trust...but it was tried and we all know what happened. We are going back to a farming society as the country winds down. Get your Victory garden going and learn how to milk a cow is my best advice. Those that live in the sticks and grow their own food will be the happiest among our population. MarvinMBA

Jan 14 01:40 AM

[Bruce Vande...:]

Would it be possible to hire someone to "audit the audit" so to speak? They would be paid on what they find is wrong with the original audit rather than just the books.

Knowing their audit will be independently checked might keep the original auditors more honest also.

If the primary auditors just "talk a great game" they should be hired by public relations department in the first place.

Jan 14 10:17 AM