April 30, 2009

1. Thomas G. Kennedy Chief Compliance Officer Fiduciary & Investment Risk Management Association 23rd Annual National Risk Management Training Conference Managing Counter-party Risk April 30, 2009 The views presented herein are those of the presenter and do not necessarily represent the views of Arden Asset Management LLC. This presentation should not be considered tax, legal or investment advice.

2. AGENDA • Managing risks in structured products and OTC derivatives distributed through wealth management platforms. • Managing brokerage counterparty risks discretionary accounts. • Managing sub-manager risk in products where manager or hedge fund selection is the basis of the product. • Conclusion.

3. STRUCTURED PRODUCTS • Manufacturer, Issuer, or Soliciting broker….any or all of these could be the source of an investor’s counterparty risk. • Bank A creates a Buffer Note on Crude Oil, issued by Bank B, and distributed by the wealth mgmt business of Bank C. • Where’s the investor’s counterparty risk? • What are the responsibilities of Bank C, the distributor? • Is there fiduciary risk involved? • Bank A creates the same note, but this time uses a Special Purpose Vehicle in Luxembourg to issue the note. The SPV does a total return swap with Bank B. Bank C is still the distributor. • How has the counterparty risk changed?

4. STRUCTURED PRODUCTS (continued) • Proprietary products versus open architecture • Best execution. • Complexity for investor and distributor. • Risk disclosures, client suitability. • Screening eligible third party issuers (agency ratings, CDS, quality of service, transactors, trading ideas, pricing). • Distribution agreements.

5. OTC DERIVATIVES • Wealth management clients may transact any of the following OTC derivatives, as hedgers or speculators: • Interest rate swaps • Credit default swaps • FX forwards or options on almost any currency pair that is tradable • Commodity or commodity index options • Equity options • Hedge fund options • Governing documentation is ISDA, along with a Collateral Security Agreement, since most are transacted on margin. • Investors in many wealth management firms take counterparty risk of the firm itself. Under open architecture, the firm may buffer the professional third party risk, and leave the retail investor only with their own performance risk. An option is to have the investor face the third party’s counterparty risk.

6. OTC DERIVATIVES(continued) • Measuring the counterparty risk of OTC derivatives • Full-life (of the underlying swap or option) pre-settlement exposure, PSE • Estimates the maximum likely change in value, to 2 std dev, with volatilities based on the highest of 6-month historical, 3-yr historical or current implied • 1-year forward USD-Euro would have a PSE of 10% of notional amt • Wealth management clients do not recognize counterparty risk bilaterally as professional counterparties do; its one-sided, banks require clients to maintain margin collateral to the extent of PSE. • Margining rules vary; a common approach for trading clients is to use 2 std deviations for a 1-week period of risk, rather than full life PSE, which could be several times larger. 25% margin erosion (mark-to-market loss) leads to a variation margin (top-up) call to be met within a day, 50% erosion results in a position sellout.

7. DISCRETIONARY MANAGED PORTFOLIOS • Investment managers may use one of several ‘approved brokers’ on their platform to execute equity or fixed income trades for client accounts. • But who bears the cost if one those (counterparties) brokers fails? • Clearing members of major exchanges will be supported by the other members; real counterparty risk lies with OTC principal trades, as with many fixed income and small cap equity transactions. • Split expectations: • The manager will claim to operate on best efforts of reasonable due diligence, and leave the client with the loss. • Clients will claim the manager has a fiduciary duty to hold them harmless. • And the investment management agreement is typically silent on the issue. • Ideally, the IMA should contain a named list of authorized brokers, or a minimum public rating standard. • Investment manager due diligence for vetting brokers may include public ratings, credit default swap levels, background checks, regulatory filings.

8. Delegation of investment authority to a third party is a matters of fiduciary judgment and discretion and require the exercise of care, skill, and caution. At a minimum, a fiduciary manager should obtain full information on an investment firm’s investment and business approaches, professional resources, financial strength, historical performance, regulatory history, personnel turnover, comparative fees, and other relevant factors. Fiduciary managers should review the following items when considering investment firms for providing investment management and advisory services. Guidelines for Selecting Investment Managers and Advisers INVESTMENT MANAGERS AND ADVISERS 7

9. Exposure to fund manager failures or blow ups can occur due to improper planning or outright fraud. Undisciplined or misunderstood investment or risk management techniques used by 3rd party managers can lead to risk. Poor internal controls allow for errors and potentially fraud to occur. Conversely a strong, scaleable infrastructure allows a manager to grow and support new products, assets, and financial instruments. Lack of adequate infrastructure or use of second rate service providers can impede the investment program of an otherwise sound manager. MANAGER SELECTION: THE CASE FOR DUE DILIGENCE 8

10. Continuous monitoring is imperative to keep track of key changes within the firm, such as staff changes, IT/system implementations, strategy/product changes, rapid growth, service providers relationships, etc. New strategies and/or securities and market risks give rise to new opportunity, but also risk and challenges. New legislation, regulatory or accounting rule changes constantly reshape organizational functions. Managers are more likely to rectify deficiencies when forced to address them with investors. WHY CONTINUALLY MONITOR MANAGERS? Fund managers are constantly evolving… 9

11. Due diligence reviews can be helpful to the manager. Deficiencies may be noted and communicated to the manager: The manager is given the opportunity to improve operational control deficiencies. Depending upon severity of the issues, initial investment can be denied or postponed pending resolution of deficiencies noted. Managers appreciate the feedback and are typically keen to understand what others in the industry are doing. Most managers want to adhere to best practices. OPERATIONAL DUE DILIGENCE 10

12. Third Party Manager Selection 11

13. Ascertain date established, ownership, affiliations. Evaluate inception date of and types of investment products and investment strategies/styles used (taxable and non-taxable). Understand amount of fully discretionary assets under management, trends. Understand client base demographics. Evaluate: Procedures for best execution/soft dollars Who makes investment decisions How securities are selected The firm’s normal portfolio turnover How are portfolios monitored for consistency with client needs and circumstances Where is research developed (internally or externally) What types of valuation models are used and how are they tested FIRM BACKGROUND AND INVESTMENT EXPERIENCE 12

14. Obtain and evaluate biographical sketches of senior firm staff involved in Portfolio Management. Trading Research/Analysis Others with significant responsibilities in the firm. Evaluate experience of investment staff by investment product and style. Evaluate names and role of third-party service providers used in investment process. INVESTMENT MANAGEMENT PERSONNEL EXPERIENCE 13

15. Review short and long-term investment performance for applicable styles, including dispersion information among portfolios. Ask how performance is calculated and whether performance results are audited. Ascertain GIPS verification. Examine the firm’s process for developing benchmarks and assessing performance against established benchmarks. Evaluate quantitative metrics and diversification guidelines or concentration limits for the following factors (Countries/currencies, Industry sectors, Issuers, Securities, Capitalization, P/E, price-to-book ratios). How does the firm manage leverage (portfolio borrowing and derivative usage). How does the firm monitor fixed income quality, duration, return, and distribution. What risk measurement and reporting systems do they use? How does the firm manage style drift? INVESTMENT PERFORMANCE AND RISK METRICS 14

16. Evaluate fee schedules. Will the firm negotiate fees? Does the firm manage separate accounts? If so, what is the minimum size? Will the firm aggregate assets when calculating fees for accounts related to a single investor/family? Does the firm have a hurdle or high watermark for incentive fees? Is there a lock-up period? How early does a withdrawal notice have to be received? Has the firm ever exercised the option to forbid investors from withdrawing from a fund? COMPENSATION/ FEES/ LIQUIDITY/ CUSTOMIZATION 15

17. Review Form ADV, an IM agreement, an offering memorandum, a subscription document, and a schedule K-1 for the product or strategy. Understand what client reporting is available including capability and time frames. Ascertain whether prices and positions reconciled with custodians. Understand and sample what type of market and portfolio commentary does the firm provide to clients and consultants, and how quickly does the firm provide it after the end of a period. Determine if the firm provides after-tax return spreadsheets. REPORTING CAPABILITIES 16

18. Hiring processes, staffing and personnel Insurance coverage. Pricing and valuation process, controls & methodology of securities. Internal compliance and audit programs and regulatory registrations. Current or past judgments, litigation, or regulatory actions against the firm or its employees. Does the firm have contingency planning and disaster control systems? − BUSINESS OPERATIONS AND INFRASTRUCTURE – POINTS TO EVALUATE • Evaluate transparency, i.e. does the firm provide access to tax-lot accounting information? • Service provider relationships, counterparty relationships and associated agreements. • IT and systems platform, disaster recovery/business continuity planning. • Trading & reconciliation process and controls, & custodial controls over assets and cash management policies. • Financial audits on the firm and products, fund accounting, audit & tax management 17

19. Suggested components of due diligence program: An onsite due diligence meeting. Review of legal documentation and other manager material. Background checks. Review of regulatory & corporate registrations. Service provider verification. Manager reference calls. OPERATIONAL DUE DILIGENCE 18

20. Monthly calls. Annual onsite due diligence update meetings. Review of manager communications, such as monthly or quarterly letters announcing organizational changes & updates. Word of mouth through industry contacts. Industry literature, newsletters, and other periodicals. MONITORING METHODS 19

21. Service providers are a critical element to the operations and success of hedge fund manager. Independently verify key service provider relationships for new managers. Fund administrator, prime brokers/custodians, auditor, valuation consultants, rating agencies, and IT/software providers. Perform due diligence on service providers. SERVICE PROVIDER DUE DILIGENCE 20

22. IN CONCLUSION • Counterparty Risks not limited to Institutional Businesses alone • Wealth management investors should become more aware of their counterparty risks in structured products, OTC derivatives and managed account portfolios • Events of the past two years, and especially the LEH bankruptcy, have heightened the awareness of counterparty risks even among professionals, whether in interbank options/swaps or prime broker margin businesses serving hedge funds • Efforts are underway to unravel the USD tens of trillions of derivatives counterparty risk, esp credit default swaps, via clearing house mechanisms • Manager selection risk has always been critical in light of spectacular manager blow-ups and more recently, there is an emphasis on operational due diligence aspects in light of the Madoff fraud. • Expect regulatory expectations and industry best practices to change.

23. OCC Asset Management Handbook MFA Sound Practices for Hedge Fund Managers PWG Asset Manager and Investor Committee Reports AIMA Guide to Sound Practices for European Hedge Fund Managers HFSB Hedge Fund Standards REFERENCES 22

24. IMPORTANT DISCLOSURE INFORMATION The views presented herein are those of the presenter and do not necessarily represent the views of Arden Asset Management LLC.. The accompanying material is was intended for information purposes only, and does not constitute a description of Arden’s investment or risk management processes. In addition, the opinions, forecast, assumptions, estimates and commentary contained in this presentation are based on the presenter’s varied experience and provided on an informal basis. This presentation should not be considered tax, legal or investment advice Further, any opinions, forecasts, assumptions, estimates and commentary are made only for information, and are subject to change at any time without prior notice. Nothing herein constitutes an offer to sell, or solicitation of an offer to purchase, any securities, nor does it constitute an endorsement with respect to any investment area or vehicle. The presenter has no obligation or responsibility to update or supplement these materials. No warranty is given as to whether any information contained herein is current and the presenter assumes no obligation or responsibility for the accuracy of the information. Some information contained herein has been obtained from third-party sources, and such information has not been independently verified. No representation, warranty, or undertaking, express or implied, is given as to the accuracy or completeness of the information contained in this material; no reliance may be placed for any purpose on such information; and no liability is accepted by any person for the accuracy and completeness of any such information. 23