A Service Provider Switch - Raise the Yellow Flag

Forbes reported that the NIR group, which has recently faced accusations of faulty returns, has just switched firms to provide valuation services. It is reported that NIR previously worked with a third-party firm for valuation services called WTAS. Interestingly, the WTAS home page describes it services as, "We specialize in full service individual and business entity tax compliance and consulting. Our goal is to provide you with opportunities and solutions to help you attain your vision." No mention of valuation services here.


The interesting part of this story is that just a few days ago NIR's Corey Ribotsky told Forbes in a statement: "It is also notable that Mr. Mizel's complaint insinuates a claim that AJW's assets have been improperly valued, yet AJW utilized a third-party valuation service (WTAS)." Even more interesting, NIR is not naming who this new mystery third party valuation agent is.

A service provider switch, regardless of which function the service provider is performing for a hedge fund should always raise a yellow flag at a minimum, if not a full blown red flag. Obviously, certain service provider functions (i.e. - auditor, administrator etc.) are more sensitive than others (i.e. - information technology provider). When evaluating a service provider switch there are three critical points to consider:

• Motivation for making a switch


• Timing of the switch


• How long the switch takes

Motivation for making a switch

Some hedge funds are proactive, others are reactive. Switching a service provider in response to litigation or a specific large investor concern may not be in the best interest of the entire organization. Other reasons a hedge fund may switch a service provider may include fees, perceptions of a particular service provider etc.

Timing of the switch

Investors should consider whether a hedge fund is selecting the appropriate time to make a service provider switch. Monitoring not only the reasons but the timing of a hedge fund's decision to terminate one service provider in place of another is also important. As an extreme example, a hedge fund switching auditors before an audit would not be the best timing.


How long the switch takes

Certain service providers take longer to complete a switch than others. Legacy hedge fund administrators for example often require a number of months at a minimum to properly complete a switch. Often times, it takes a few months of running in parallel with two administrators to complete a switch. A hedge fund may announce a switch, but it may not be completed in actuality for quite a long time. Hedge funds can take several steps to facilitate this process before a switch is complete and investors should inquire as to whether a hedge fund has taken such steps.

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The importance of independent valuation for private investments

Forbes is reporting today that the NIR Group (whose website states Experience, Integrity, Performance) is being accused of running an investment scam. The details emerged in a lawsuit filed by investor Steven Mizel against NIR which is run by Corey Ribotsky out of Roslyn, NY. This is the second major alleged hedge fund fraud to come out of Long Island. The previous one was Nicholas Cosmo's Agape World from Hauppauge, NY.


A lawsuit filed against Mr. Ribotsky (a graduate of Brooklyn Law School) and NIR AJW Qualified Partners claims that they, "appear to have provided investors with valuations of the Fund's securities which are wholly fanciful." In March this year it was reported that NIR settled a lawsuit from Gerald and Michael Tucci and Plum Beach Partners related to a delayed payout of a redemption).

NIR’s primary investment strategy was to participate in PIPEs (private investments in public equity). Forbes also reported that in those deals Ribotsky invested cash in thinly traded public companies, in return for securities convertible into discounted common shares of the company. The result of a Ribotsky investment has often been that the company's stock plummets in value, but Ribotsky has continued to post excellent returns. In a note to investors last year, Ribotsky said one of his main funds was up 8.27% in the first nine months of 2008 and that NIR Group funds had experienced "little volatility and have had positive returns in 114 out of 117 months."

Here is a link to an interview Mr. Ribotsky conducted with Bloomberg (with an odd disclaimer):

Aside from the numerous redemption and gate issues surrounding this case, NIR’s situation highlights the importance of both on-going due diligence and independent valuation. Continuous positive performance in light of a market which would generally cause a decline in a particular hedge fund strategy is certainly a red flag. Risk management and analysis not only of performance data but portfolio holdings to monitor such things as style drift can often detect when a hedge fund manager is straying from their original investment profile or perhaps even inflating (or dampening) performance.



Such situations often revolve around valuation issues. When there is a lack of independent oversight in the valuation process the hedge fund manager often has too much control on striking portfolio marks. Exacerbating the situation, is that investors often do not have the level of transparency necessary to gauge whether such valuations are inflated. An independent administrator can help to mitigate such risks, but only if they are valuing the entire portfolio and not performing a NAV light rubber stamp review.

Ultimately, the investor has responsibility for gauging the independence and accuracy of valuations of private investments for which the hedge fund manager may determine the mark. Detailed initial and on-going operational due diligence can facilitate this process. Often red flags travel in packs and investors performing frequent operational due diligence reviews increase the odds of spotting yellow flags before they turn red. This allows investors to redeem before a gate is invoked or they end up in court trying to get their money back.

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