JPMorgan Chase & Co is in the news with some frequency these days, primarily for its corporate risk management practices. We examined the firm in its capacity as a Securities and Exchange Commission registered investment advisor. JPMorgan came up very high on our list of regulatory violators in a recent industry research report our firm prepared on private fund advisors. Specifically, JPMorgan had seven categories of significant adverse regulatory events.
We examined JPMorgan's Form ADV Schedule D data (See Note 1) to learn the dollar value of private fund assets the firm manages for clients. JPMorgan manages the following private fund assets:
Private Fund Type
Private Equity Fund-of-Funds
Other (e.g. infrastructure)
When we look at a private fund advisor's ADV we ask, "What does the information tell us?" and "What questions are unanswered?" In this case, the questions raised are not for JPMorgan but for those who invest in JPMorgan's hedge funds.
Specifically, we ask JPMorgan's hedge fund investors:
- Did you review the ADV? The ADV review is the first step of any investor due diligence process. After examining the ADVs, our professional judgment is that JPMorgan has an inability and/or an unwillingness to follow laws and regulations. This behavior extends to the asset management business. We consider JPMorgan's violations to be the most serious of red flags. If an investment advisory firm is chronically unable or unwilling to follow the law, one cannot predict that the firm will behave lawfully, including the ultimate return of client assets.
- Are you aware that JPMorgan uses a related party as hedge fund administrator and a related party as custodian for its managed hedge funds? JPMorgan manages, holds, and determines the value of nearly all of its clients' hedge fund assets (See Note 2). In a post-Madoff world, it is widely accepted that separation of duties is prudent. Competent, non-related entities should be performing the functions of custodian and fund administrator.
- What evidence do you have that JPMorgan will be loyal to you? The ADV illustrates numerous types of conflicts of interest at JPMorgan. JPMorgan competes with its own clients in many ways. For example, JPMorgan acts as a prime broker and service provider to hedge funds. It also selects hedge funds for its funds-of-funds. It also competes directly with its hedge fund clients by offering its own hedge funds to investors. If the firm competes against its most sophisticated clients in this way, where are you in the pecking order?
- Does fund performance meet your expectations, and are you confident that asset valuations are accurate? This is an appropriate question for all hedge fund investors and particularly for JPMorgan investors, in light of Questions 1, 2 and 3 above. Hedge fund performance should be consistent with the strategy employed by the investment advisor. Although each hedge fund is unique, performance should be compared to a relevant benchmark (e.g., HFN Indices) for reasonableness. For hedge funds that invest in less liquid or harder-to-price assets, investors also should expect independent valuation practices to be in place.
Individual investors should always review investment advisors at the SEC website and FINRA's BrokerCheck. Institutional investors that engage JPMorgan as a hedge fund advisor should direct the above questions to consultants and staff. Our experience tells us the most significant due diligence concerns are often out in plain sight. It's up to investors to look and act upon what they see.
Note 1: May 2012 Forms ADV of J.P. Morgan Securities LLC (SEC #801-3702), J.P. Morgan Asset Management (SEC #801-64725), J.P. Morgan Asset Management (SEC #801-21011), J.P. Morgan Private Investments, Inc. (SEC#801-41088), JPMorgan Alternative Asset Management (SEC #801-38319), and J.P. Morgan Latin America Management Company, LLC (SEC# 801-57330) and JPMorgan Partners (SEC# 801-58234). Company name spellings are as they appear in the filings.
Note 2: Schedule D of Form ADV indicates that for the large majority of JPMorgan managed hedge funds, the hedge fund custodian is JPMorgan Chase, N.A. The fund administrator is, in the majority of funds, is identified as J.P. Morgan Investor Services Co. Hedge Fund Services. Please check your particular hedge fund in Form ADV Schedule D to see what related parties, if any, perform these functions.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.