Accounting Firms Overview

   The revelation a year ago that Bayou Management — a onetime $450 million Stamford, Connecticut, hedge fund firm — had for years been fabricating independent auditor reports from a fictitious accounting firm shocked many investors. Although the firm’s co-founders, Samuel Israel III and Daniel Marino, have since pleaded guilty to fraud charges and are awaiting sentencing, the impact of Bayou’s alleged Ponzi scheme is still being felt, especially among accounting firms.

   “Since Bayou we find we are receiving more inquiries to confirm if we are the auditor [to a hedge fund client],” says Robert Castro, managing director, financial services, for Chicago-headquartered accounting firm BDO Seidman. “These questions are coming from current investors, prospective investors and outside consultants to firms.”

   The Bayou scandal highlights the importance of outside auditors in legitimating and verifying the practices of their hedge fund clients. Investors, keen to ensure that the auditors of their hedge funds are not acting like a rubber stamp, are pressuring their managers to use respected, well-known firms, says Castro, who works out of BDO Seidman’s New York office.

   Although the flight to quality by investors has undoubtedly helped win business for the Big Four — Deloitte Touche Tohmatsu, Ernst & Young, KPMG and PricewaterhouseCoopers — smaller firms like Castro’s have also benefited. BDO Seidman is the No. 1 accounting firm in this year’s Alpha Awards™, handily unseating 2005 winner Rothstein Kass & Co. of Roseland, New Jersey. BDO Seidman is the only firm in this year’s survey to finish first in each aspect of service on which we asked clients to rate it. The firm’s clean sweep includes Alpha Awards in audit, client service, hedge fund expertise, regulatory and compliance, and tax.

   Of the Big Four, only Deloitte Touche ranks among the top five overall winners. Castro suggests that more-specialized accounting firms tend to fare better among hedge funds because the managers, especially during the start-up phase, need more-personalized support. “The reason you see smaller firms and local firms doing well is that many of these hedge fund managers got their start in large capital markets firms as traders and money managers,” he says. “They are new to running a business and tend to require more hand-holding.” Once managers get used to that level of service, Castro adds, there’s no going back.

   Like those of other hedge fund service providers, the job of auditors is becoming more challenging and varied. Institutional investors, regulators and others are paying greater attention to hedge funds’ books — looking not only at the accuracy of the accounting but also at the valuation of securities. The latter is becoming increasingly important as hedge funds invest more in hard-to-value asset classes.