1. Stephen Brown, NYU William Goetzmann, Yale Bing Liang, U Mass Christopher Schwarz, UC Irvine

4.  Is SEC registration useful?  What correlates to operational risk?  Can we predict operational event?

5.  Form ADV Item 11: legal and regulatory problems.  A “Problem” fund = a fund whose management company answered ‘Yes’ to ANY question on Item 11 of Form ADV.  Past Suspension  Past Fine  Other Legal or Regulatory issue

6. 1814 358 10295 1526 0% 20% 40% 60% 80% 100% Hedge FundsAll Advisers Problem Non-Problem

7. "Problem" Funds"Non-Problem" Funds No. Funds% YesNo. Funds% Yes Broker/Dealer36873.10192923.70 Investment Comp36850.30192915.80 Investment Adviser36873.90192941.60 Commodities Broker36853.50192920.70 Bank36840.5019299.80 Insurance36839.9019298.30 Sponsor of LLP36856.80192921.50 **, * significant at one and five percent respectively Mandatory Disclosure and Operational Risk: Evidence from Hedge Fund Registration, Stephen Brown, William Goetzmann, Bing Laing, Christopher Schwartz, Not for reproduction or citation or quotation without authors’ permission

8. "Problem" Funds "Non-Problem" Funds No. Funds% Yes No. Funds % Yes Buy Sell Your Own36830.719298.3 Buy Sell Yourself Clients36884.8192969.3 Recommend Sec You Own [Rec] 36875.5192950.4 Agency Cross Trans36830.719292.3 Rec Underwriter36869192947 Rec Sales Interest36822.6192915.7 Rec Brokers36846.7192938 Other Research36881192970.5

9. **, * significant at one and five percent respectively From Mandatory Disclosure and Operational Risk: Evidence from Hedge Fund Registration, Stephen Brown, William Goetzmann, Bing Laing, Christopher Schwartz, Draft: October 11, 2007. Not for reproduction or citation or quotation without authors’ permission 4.17 1.31 -1.21 1.8 0.44 -0.25 -2.53 0.52 -1.56 4.19 3.57 -4.73 2.14 3.38 -1.56 0.58 -1.18 -2.15 -6 -5 -4 -3 -2 0 1 2 3 4 5 Log(Assets)Fund Age (Years) Std DevOnshoreIncentive FeeHigh Water Mark RelationshipDirect Domestic Percent own 75% t-value

10.  We need PAST ADV problems  Difficult to get from SEC  Instead, we can use observables  “Rotation” of Lipper-TASS variables and “Rotation” of ADV characteristics that are most highly correlated.  Canonical correlation.  Use this model with historical data.

11.  A propensity score for “problem”  Uses TASS data (widely available)  As good as we can do without a research and due diligence team  A linear factor model  Does it predict fund disappearance?  Back-test

12. From Estimating Operational Risk For Hedge Funds, The Ω-Score, Stephen Brown, William Goetzmann, Bing Laing, Christopher Schwarz. Not for reproduction or citation or quotation without authors’ permission.

13.  Is the half-life of the fund related to the omega score?  Other factors – age.

14. 0.4 0.6 1.01.2 0. 7 0.6 0.5 0.4 0.3 0.2 0.1 90 months 80 70 60 50 40 Half Life Financial risk (prior monthly  ) Operational Risk  -Score 0.8

15.  Market alternative to regulation  Not all funds register  Due diligence before investing

16.  445 DD funds over past decade  DD decision endogenous  Past returns.  Different thresholds for problems based on returns.  Focus on honesty

17. Database MatchesAll Funds CoefChi SqCoefChi Sq Log Assets0.36391.54**0.32467.76** Management Fee0.2695.95*0.40218.31** Incentive Fee0.04714.24**0.05622.81** High Water Mark0.64312.64**0.79422.20** Leveraged0.0360.08-0.0730.40 Red Notice Period0.00711.78**0.00925.87** Lockup Period-0.03511.51**-0.03716.20** Return Mean0.850146.21**0.865149.68** Return Std. Dev.-0.45987.88**-0.48097.58** Ret Autocorrelation0.2570.82-0.0990.16 Year DummiesYY Style DummiesYY Clustered by FundYY Fund Year Observations 26,12726,219 Number of Funds9,0019,093 R-Squared0.25

20. DD Funds Non-DD Matched Funds Differencep-value Flows1.4910.6410.8500.00 Problem Flows1.6750.7360.9390.00 Non-Pro Flows1.2920.5380.7540.00 Appraisal ratio0.2160.1330.0830.26 Problem A ratio0.2490.1840.0650.62 Non-Pro A ratio0.1840.0850.0990.16

21. Model 1Model 2 coefficientChi-sqcoefficientChi-sq Return mean0.0160.02-0.0800.33 Return Std. Dev.0.0731.160.1101.97 Return Autocorr0.1860.34-0.0190.00 Log(assets)0.0220.200.0150.08 Fund age0.0040.020.0270.59 Management fee-0.2222.06-0.1750.84 Incentive fee-0.0120.46-0.0140.41 Lockup period-0.0050.150.0030.05 Notice period0.0070.11-0.0010.29 Non-Verification0.50512.09**0.3694.66* Signature0.1150.450.0320.03 Self-Pricing-0.2536.56*-0.2985.77* Big 4 auditor-0.4448.31**-0.4706.53* # Ind Board-0.2741.14 Lambda0.2470.920.0450.02 Style DummiesYY

22. Model 1Model 2 coefficientChi-sqcoefficientChi-sq Return mean-0.0070.00-0.0730.21 Return Std. Dev.-0.0080.010.0360.15 Return Autocorr0.2790.630.1750.17 Log(assets)-0.1023.14-0.1022.42 Fund age0.0351.190.0481.25 Management fee0.1310.580.0250.41 Incentive fee-0.0080.17-0.0170.13 Lockup period0.0090.500.0030.03 Notice period-0.0020.00-0.0051.21 Inconsistency0.2952.700.3903.26 Signature IQ-0.0270.02-0.0450.04 Pricing-0.0650.37-0.0490.12 Big 4 auditor-0.3885.37*-0.5446.94** # Ind Board0.2320.59 Lambda-0.2440.63-0.3971.20 Style DummiesYY Num Obs.380287

23. All FundsNon-Problem FundsProblem Funds Coeff.t-valueCoeff.t-valueCoeff.t-value Lawsuit0.7141.67 Regulatory0.4610.88 Misrepresentation0.4681.02 Return Mean-0.547-1.34-0.062-0.11-1.628-2.72** Return Std. Dev.0.0730.36-0.072-0.270.3771.27 Return Autocorr1.1181.320.5170.460.6890.56 Log(assets)-0.911-4.81**-0.533-2.25*-1.604-5.39** Fund age-0.120-1.38-0.220-1.870.0810.66 Management fee0.1650.390.4320.700.6491.13 Incentive fee0.0130.210.0090.130.0700.62 Lockup period0.0260.810.0611.490.0400.86 Notice period0.0000.000.0030.28-0.005-0.47 Non Verification-0.556-1.24-0.643-1.14-0.311-0.46 Signature IQ0.4800.92-0.753-1.091.6082.12* Pricing0.1960.750.3881.07-0.197-0.54 Big 4 auditor0.3870.870.8141.28-0.396-0.64 Lambda-1.125-1.33-0.050-0.05-2.926-2.38* Style DummiesYYY Adjusted R-squared0.170.070.33 Num Obs.19795102

24. All FundsNon-Problem FundsProblem Funds Coeff.t-valueCoeff.t-valueCoeff.t-value Lawsuit-0.115-0.68 Misrepresentation0.3972.18* Regulatory-0.141-0.69 Log(assets)-0.026-0.43-0.079-1.460.0090.07 Fund age-0.069-2.06*-0.020-0.69-0.110-1.77 Autocorrelation-0.081-0.240.5331.81-0.325-0.52 Management fee-0.253-1.56-0.272-1.820.0000.00 Incentive fee0.0382.01*0.0020.160.1132.49* Lockup period-0.013-1.11-0.019-1.890.0010.03 Notice period0.0093.26*0.0031.360.0122.58* Inconsistency-0.005-0.290.1040.72-0.154-0.49 Pricing-0.284-2.82*0.0400.44-0.606-3.45** Signature IQ-0.066-0.040.0030.020.0720.21 Big 4 auditor-0.196-1.14-0.265-1.60-0.340-1.16 Lambda0.5072.55*-0.053-0.310.9332.63* Style DummiesYYY Adjusted R-squared0.120.090.15 Num Obs.266138128

25.  Hedge fund opacity demands trust  Problem funds have:  Verification problems  Minor auditors  More likely to self-price