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Index

A Barlow Clowes International Ltd AA Capital fraud, 318–321 (In Liquidation) v. Eurotrust Accessory liability, 212–213 International Limited, 213 Actual fraud. See Fraud Basel Committee on Banking Administrator, 143–145, 341–345 Supervision, 21 ADV. See Form ADV Benchmarking. See Operational Advisory board, 301–313 Benchmarking Agape World, 18 Berman, Todd, 321–323 Allianz SE, 325–326 Blackstone Group, 20 Alternative Investment Fund Board of directors, 26, 205, 302, Managers Directive 322 (“AIFMD”), 21, 58, 355 Boesky, Ivan, 19 Alternative investments, 4–16, 56, British Venture Capital Association 58, 74, 146, 159, 210 (BVCA), 58, 183 Amazon.com, 20 Broker-dealer, 162 American Research and Bullmore v. Ernst & Young Development Corporation Cayman Islands, 217 (ARDC), 19 Business continuity and disaster Assembly Bill 1743, 161 recovery planning (BCP/DR), Asset allocation, 275–300 26, 114, 132, 165–168 Assets under management (AUM), Business risk. See Operational risk 57, 100, 129,http://www.pbookshop.com 193, 220 Audit materiality, 238–240 C Audited financial statements. See Cadbury Commission, 21 Financial statements California Public Employees’ Auditor, 143 Retirement System (CalPERS), COPYRIGHTED161 MATERIAL B California State Teachers’ Background investigation, 177–179 Retirement System (CalSTRS), Bad faith, 221–226 161 Baden v. Societe Generale, 213 Carlyle, 9 Balance sheet. See Financial Carnegie Steel Company, 18 statements Carnegie, Andrew, 18 Barings Bank, 22 Carried interest, 140, 227, 270

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364 INDEX

Cash oversight, management and Cosmo, Nicholas, 18 transfer controls, 23, 162–165 Counterparty oversight, 131 Cayman Islands, 34, 91, 145, 218 Counterparty risk. See Channel Islands, 34, 215 Counterparty oversight Chartwell Investments, 321–323 Country specific risks, 33–35 Chief Compliance Officer, 92, 178 Credit Mobilier, 18 Chief Financial Officer, 92, 178 Crossover funds, 8 Chief Operating Officer, 178 Custodian, 146 Chief Technology Officer, 92 Custody 23, 104, 136–137, Cliff vesting. See Compensation 146–147, 170, 293–294, 344, structures 356 Committee of Sponsoring Custody Rule, 146 Organizations (COSO), 21 Customer relationship management Committee of Wise Men, 57 (CRM) systems, 147, 174 Compensation structures, 138–139 Compliance D Infrastructure, 23, 26, 52, 136 Dedicated framework, 91–95 Manual, 113–115, 153, 347, 357 Department of Justice, 162, Compton, Carl, 19 320 Confidentiality agreement, 106–113 Deutsche Bank, 9 Conflicts of interest, 266–267, Digital Equipment Company, 19 334–335 Director liability, 213 Continental Airlines, 20 Directors’ and officers’ liability Cooke, Jay, 18 coverage (D&O), 173 Core operational due diligence Discovery, 81–82 process. See Operational due Dishonesty, 212–213 diligence Distressed debt investing funds, 8, Core operational due diligence 223 process. See Operational due Dixon, Roy, Jr., 324–325 diligence http://www.pbookshop.comDodd-Frank Wall Street Reform Corgentum Consulting and Consumer Protection Act, Benefits of operational due 21, 57, 355–357 diligence case studies, 17 Dom, Telonge, 160 Increased use of operational due Domino’s Pizza, 20 diligence consultants, 350–352 Doriot, Georges, General, 19 Operational due diligence process Draper Gaither and Andersen, 19 documentation, 53 Dreier, Marc, 18 Operational benchmarking, 54 Drexel Burnham Lambert, 19 Operational due diligence Due diligence equation, 39 frameworks analysis, 91–95 Due diligence file, 81 Trends in indemnification and Due diligence questionnaire (DDQ), exculpation clauses, 217–227 87, 121–123 P1: TIX/XYZ P2: ABC JWBT643-IND JWBT643-Scharfman February 9, 2012 13:54 Printer: Yet to Come

Index 365

E Financial statements EBITDA, 139, 187 Audit standards, 233–237 Effectively connected income (ECI), Due diligence on, 233–255 176 Review of in core process, 23 Enron, 20 Sections, 245–248 Equity ownership model, Firm and employee reputation, 178 130–131, 177–179 Errors and omissions (E&O) Foreign Corrupt Practices Act, 162, insurance, 173 325 EU passport, 58 Form ADV, 59 European Association for Investors Form PF, 59 in Non-listed Real Estate Fraud Vehicles (INREV), 237 Applicable to exculpation and Exculpation and Indemnity indemnity, 211–212 Exception to, 211–220 Benefits of case studies in, 17 History of, 207–208 Case studies in, 315–326 Uses in private equity offering Detection of, 5–7 memoranda, 208–211 Investor recovery from, 5 Exculpation. See Exculpation and Levels of, 6 Indemnity Private equity fund failure Exogenous risks, 60, 65, 165–166, considerations due to, 68 220 Fraud in fact. See Fraud Expanded operational due diligence Fund Administrator. See process. See Operational due Administrator diligence Fund advisory board. See Advisory Expert research networks, board 345–348 Fund reporting, 3, 23, 131, 136, 183, 277, 356 F FAA System Safetyhttp://www.pbookshop.com Handbook, 2 G Fair value. See Valuation Galleon Group, 345 FAS 157, 189–191, 251–253 Geithner, Timothy, 57 FASB ASC 820, 190 General Counsel, 92 Fat-tail risk General Partner (GP) Defined, 1 Defined, 10 Relation to fraud detection, 5 Distinction in valuation Financial Accounting Standards approaches, 181–182, Board (FASB), 189, 235 197 Financial Highlights, 248 Relation to advisory boards, Financial Institutions Reform, 302–303 Recovery and Enforcement Act Information flow with Limited of 1989, 19 Partners, 306–307 P1: TIX/XYZ P2: ABC JWBT643-IND JWBT643-Scharfman February 9, 2012 13:54 Printer: Yet to Come

366 INDEX

Generally Accepted Accounting I Principles (GAAP) ILPA. See Institutional LPs Convergence with IFRS, Association (ILPA) 236–237 Guidelines U.S. GAAP, 176, 235–236, 248 In pari delicto, 216–217 U.K. GAAP, 235–236 Indemnity. See Exculpation and Generally Accepted Auditing Indemnity Standards (GAAS), 234 India private equity funds, 34–35, Global Investment Performance 61 Standards (GIPS). See Industry specific risks, 35–39 Valuation Information barrier, 72–76 Goldman Sachs, 9 Information security, 26, 132 Goldstein, Philip, 56 Information silo, 200 Graham v. Allis-Chalmers Mfg. Information technology (IT). See Co., 215 Technology and systems Greenbury Committee, 21 Information technology Gross negligence, 213–214 consultants, 147 Guernsey, 34, 218, 224, 328 Informed operational opinion Guidelines for Disclosure and formation, 25 Transparency in Private Institutional LPs Association (ILPA) Equity. See Walker Guidelines Guidelines, 354–355 Insurance coverage, 26, 130, H 173–174 Hampel report, 21 International Auditing Standards Harvard, 19 (ISA), 234 Health care fund, 12, 333 International Business Machines Hedge Clauses, 209–111 (IBM), 18 Hedge fund operational due International Financial Reporting diligence Standards (IFRS), 176, Differences withhttp://www.pbookshop.com private equity 236 operational due diligence, International Private Equity and 44–49 Venture Capital Valuation Similarities with private equity (IPEV) Guidelines operational due diligence, Discount cash flows or earnings 40–44 (of underlying business) Hedge fund Registration Rule, 56 approach, 188 Hedge Fund Transparency Act, Discounted cash flows (from the 56–57 investment), 188 High Voltage Engineering Industry valuation benchmarks Corporation, 19 approach, 188–189 Human capital, 23, 26, 136, 280 Multiple valuation methodology, Hybrid framework, 91–95 186–187 P1: TIX/XYZ P2: ABC JWBT643-IND JWBT643-Scharfman February 9, 2012 13:54 Printer: Yet to Come

Index 367

Net assets approach, 187 Keynesian economics, 22, 62 Price of recent investment Kiener, Helmut, 18 approach, 185–186 KKR, 9 International Standard of Assurance Klomp, Danny, 321 Engagements (ISAE) 3402, 349 Interval funds, 8 L Investment Adviser, 10 Lamfalussy procedure, 57 Investment Advisers Act of 1940, Lascaux Cave, 2 56, 146, 161, 210 Legal and compliance risks, 130, Investment decision making 171–173 authority model, 178 Legal counsel, 145–146 Investment due diligence Legal documentation review. See Comparison to operational due Legal due diligence diligence, 99, 275, 351 Legal due diligence, 23, 198–228 Defined, 51 Lesson, Nick, 22 In shared due diligence Leveraged buyout (LBO) framework, 91 LBO funds, 8, 19 Integration with operational due RJR Nabisco takeover, 19 diligence, 39 Levine, Dennis, 19 Process timing, 36–37, 65, 98–99 Liability releases, 214–2146 Relation to fraud detection, 6 Liechtenstein, 34 Resource allocation versus Limited liability company, 10 operational due diligence, Limited Partner 27–30 Defined, 10 Role in private equity Distinction in valuation decision-making process, 11 approaches, 181–182, 197 Stages of analysis, 13 Serving on Advisory boards, ISDA, 26 302–303 Isle of Man, 34, 218, 224–225 Information flow with General http://www.pbookshop.comPartner, 306–307 J Fund of funds due diligence Jersey, 34, 215, 218, 224–225 considerations, 307–308 Jurisdictional risks, 35 Litigation support, 80–82 J.P. Morgan, 18 Lockup, 65–68, 79–80 Junk bonds, 19 Luxembourg, 34

K M K1 Group, 18 Madoff Effect, 17 Key person clause, 227, 291, 312 Madoff, Bernard, 6–7, 16–18, 59, Key person insurance, 174 146, 250, 294, 315 Keynes, John Maynard. See Malfeasance, 214, 221–225 Keynesian economics Malta, 34–35, 60–61 P1: TIX/XYZ P2: ABC JWBT643-IND JWBT643-Scharfman February 9, 2012 13:54 Printer: Yet to Come

368 INDEX

Manager. See Investment adviser On-site visits Markets in Financial Instruments Documentation for litigation Directive (“MiFID”), 21, 57 support, 81–82 Material nonpublic information, Interview techniques and 345–348 question design, 150–154 Mezzanine financing funds, 8, 222 Negative operational due Minimum operational risk regime diligence, 148–150 (MORR), 280–285 Private equity fund manager MIT, 19 considerations, 125–128 Modular framework, 91–95 Underlying private equity Moral fraud. See Fraud portfolio companies, 156 Mortgage fraud, 269–270 Onyx Capital Advisors, 324–325 Muntefering,¨ Franz, 9 Operational Benchmarking, 353–354 N Operational Drag, 286–290 Nadel, Arthur, 18 Operational due diligence National Commission on Arguments in favor of performing Fraudulent Financial on private equity, 75 Reporting, 21 Below-core process, 27 Negative operational due diligence. Compared to operational risk, 4 See On-site visits Contrasted with an insurance Netscape, 20 policy, 68 No-fault divorce provision, 311 Core process, 8, 23, 85–133 Nondisclosure agreement (NDA), Defined, 4–5 106–113 Distinguished from operational Noninvestment risk. See management, 9–10 Operational risk Document collection, 113–133 Expanded process, 26 O Filtering stages, 12 Offering memorandumhttp://www.pbookshop.com (OM). See Five-stage process, 101–103 Private placement Frameworks, 91–95 memorandum Lack of universal definition, 4 Offshore block corporation, 177 Private equity program design, Offshore jurisdictions 87–100 Onshore versus offshore Process goals, 52–55 considerations in legal Process timing, 10–13, 97–99 document analysis, 205 Resource allocation, 90–91 Private equity fund managers Time versus resource allocation, choice of, 61 72 Service providers location in, 145 Trends in, 341–358 Tax policy, 34 Understanding time allocation to, Ongoing monitoring, 292–296 27–29 P1: TIX/XYZ P2: ABC JWBT643-IND JWBT643-Scharfman February 9, 2012 13:54 Printer: Yet to Come

Index 369

Universal definition, 7 Pay-to-play, 160 Versus operational risk, 3–4 PEMGroup Fraud, 316–318 Operational due diligence Performance vesting. See consulting firm. See Corgentum Compensation structures Consulting Personnel and employee turnover, Operational fringe, 87–90 129 Operational Lift, 286–290 Petco, 20 Operational Lift-to-Drag ratio, Petters Group Worldwide, 18 286–290 Petters, Tom, 18 Operational risk Philips Pension fund fraud, Common private equity 323–324 operational risk categories, 3 Picasso, Pablo, 2 Compared to operational due Pinata˜ problem, 118 diligence, 3–4 PIPE transactions, 8, 20, 345 Defined, 1–3 Ponzi scheme, 5–6, 16–18, 56, Operational risk plane, 68–71 146–318 Risk commonalities between Ponzimonium, 18 private equity and real estate, Portfolio companies, 9–10 30–31 Positive fraud. See Fraud Risk differences between private Private Equity equity and real estate, 32–33 Private equity fund of funds, Operational risk consulting firm. Private placement memorandum See Corgentum Consulting (PPM), 201–206 Operational risk management Process homogeneity, 95–97 (ORM). See Operational risk Public Company Accounting Operations risk. See Operational Reform and Investor risk Protection Act of 2002. See Opinion letter. See Financial Sarbanes-Oxley Act statements Ops dd. See Operationalhttp://www.pbookshop.com due Q diligence Quaker Oats, 20 Orecchio, John, 318–321 Organizational risk. See R Operational risk R. Allen Stanford, 18 Rajaratnam, Raj, 345 P Real estate Palminvest, 321 Distinguished from private Pang, Danny, 316–318 equity, 257–278 Paper Trail. See Litigation support Feasibility study, 258 Pari Passu, 116, 157–158, 218. Fund fees, 270–271 226, 242 Property management, 260–261, Pay-for-play. See Pay-to-play 267–269 P1: TIX/XYZ P2: ABC JWBT643-IND JWBT643-Scharfman February 9, 2012 13:54 Printer: Yet to Come

370 INDEX

Real estate (Continued ) Shared framework, 91–95 Risk commonalities with private Side letters, 290–292 equity, 30–31 Signaling effect, 104 Risk differences with private Silicon Valley, 19 equity, 32–33 Snapple Beverages, 20 Sample process, 258–262 Snowball Effect, 330–332 Technical due diligence, 259 Standard Chartered, 317 Third-party developers, 260 Stanford Financial Group, 18, 146 Valuation, 262–266 Statement of Assets and Liabilities. Rebate. See Sales charge See Financial statements Regional risk. See Industry specific Statement of Cash Flows. See risks Financial statements Regulatory risks, 26, 171–173 Statement of Changes. See Financial Reputational risk. See Firm and statements employee reputation Statement of Financial Accounting Resource dilution, 95–97 Standards 157. See FAS 157 RICS Valuation Standards, 264, Statement of Operations. See 266 Financial statements Risk control model, 178 Statement on Auditing Standards Rogue trader events, 21 (SAS) No. 70, 348–350 Royal Brunei Airlines Sdn. Bhd. v. Straw-man borrower, 269–270 Tan, 212–213 Royal Institution of Chartered T Surveyors, 266 Tax haven, 327–328 Rule 206(4)-2. See Custody Rule Tax practices, 26, 175–177 Technology and systems, 26, 131 S Third-party marketer, 159–162 Sales charge, 159 Timber investment management San Diego v. Amaranth, 213 organization (TIMO), 36, 238 Sarbanes-Oxley Acthttp://www.pbookshop.com (SOX), 20–21, Time vesting. See Compensation 234 structures Savings and loans (S&Ls), 19 Trade flow analysis, 23, 26, Schedule of investments. See 168–171, 257–258 Financial statements Trade life cycle. See Trade flow Scoop Management, 18 analysis Securities and Exchange Transcontinental Railroad in the Commission (SEC), 56, 91, United States, 18 146, 210, 321 Transparency and fund reporting, Service level agreement (SLA), 137 131 Service providers, 23, 132, 141–147 Treadway Commission, 21 SFAS 157. See FAS 157 Tyco International, 20 P1: TIX/XYZ P2: ABC JWBT643-IND JWBT643-Scharfman February 9, 2012 13:54 Printer: Yet to Come

Index 371

U Venture capital funds, 8, 19–20, 40, U.S. GAAP. See GAAP 45, 57 U.S. Generally Accepted Auditing Vesting. See Compensation Standards (GAAS). See structures Generally Accepted Auditing Villalobos, Alfred, 161 Standards (GAAS) Vintage fund Ultra vires, 215 Financial statement due diligence Uninterruptible power source on, 241–244 (UPS), 167 Valuation considerations, Unrelated business taxable income 182 (UBTI), 176 Side letter negotiation concerns, 291 V Viscount of the Royal Court of Vaisey, Harry Sir, 107 Jersey v. Shelton, 215 Valuation Voortman, Remco, 321 Considerations for newly formed funds, 182 W Consultants, 264–265 Wagoner Doctrine, 216–217 Distinction between fund and Walker Guidelines, 21, 58 portfolio company level, Weather-related risks, 24, 165 181–182 Willful default, 211–212 Fair value, 183, 185–195 Willful fraud. See Fraud GIPS Statement of Private on Worldcom, 20 Private Equity Real estate, 262–266 Review of in core process, 23 Y Third-party consultants, 191–196 Yahoo!, 20

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