The 2014 Alpha Awards: Top Accounting Firms

If the U.S. Securities and Exchange Commission suddenly showed up at your hedge fund firm to conduct a surprise audit, would you be ready?

Natalie Deak Jaros, a partner in the hedge fund services group at accounting firm Ernst & Young, wants to make sure her clients can answer that question with a resounding yes. Deak Jaros says many hedge fund managers have enlisted her company’s help since the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which requires hedge fund firms with more than $150 million in assets to register with the SEC. Because all registered hedge funds are subject to random SEC exams, firms that are registering for the first time — and therefore unfamiliar with the agency’s requirements — are paying lofty prices for mock regulatory exams to identify shortcomings in their operational procedures and compliance before the SEC officially conducts its review. This uncertainty is not limited to new funds. Those that have already registered struggle to comply with complex new regulations that are continually being issued. That’s where firms like Ernst & Young come in.

“Until the regulations, managers weren’t really that concerned with mock exams, but we’ve seen more of it since there’s a greater percentage of the industry regulated now,” says Deak Jaros.

Dodd-Frank’s registration requirement is just one of many new rules and regulations that hedge fund managers have had to come to grips with since the financial crisis of 2008. The accounting firms best equipped to handle these challenges are the so-called Big Four — Deloitte Touche Tohmatsu, Ernst & Young, PricewaterhouseCoopers and KPMG — according to the hedge fund managers who voted in this year’s Alpha Awards ranking of the top service providers that cater to them.

Ernst & Young leads the lineup, followed closely by PwC at No. 2 and KPMG at No. 3. Of the Big Four, only Deloitte, the world’s biggest accounting firm by revenue, falls short of the top five, sneaking in at No. 6. EisnerAmper takes fourth place, while BDO, a favorite among hedge fund firms before the financial crisis, wins fifth place.

As with the overall ranking, Ernst & Young captures the crown in all five of the aspects of service on which hedge fund professionals were asked to rate the accounting firms: Audit, Client Service, Hedge Fund Expertise, Regulatory & Compliance and Tax. PwC comes in second for all categories except Tax, where KPMG nabs the No. 2 spot. Deloitte, the biggest of the Big Four after raking in $32.4 billion in revenue last year, lags its main competitors in the rankings, placing No. 3 in Audit and No. 5 in Client Service.

The rise in prominence of the Big Four in the rankings is propelled in part by their deep-rooted global presences, which give them an advantage in garnering business from hedge fund firms that are opening offices outside the U.S. and trading more internationally, says Ernst & Young’s Michael Serota, financial services partner and global hedge fund services co-leader. The Big Four firms collectively employ more than 714,000 accounting professionals in at least 157 countries, and the number continues to grow annually. In the past year alone, for instance, KPMG added 3,000 trained auditors to its global workforce, expanding its talent pool to 155,000 professionals.

Though top-ranked Ernst & Young trails its Big Four competitors in size and revenue — it reported 2013 revenue of $25.8 billion — it supersedes them in value, according to clients who praise the firm for delivering the most added value in tax services and audit support. One praises Ernst & Young as being very thorough, with “an excellent standard across all that we use them for.” Raves another, “They are perfect — what you want from your audit/tax firm.”

Timeliness in audits is crucial for hedge funds to meet regulatory deadlines, clients agree, and Ernst & Young adheres to a very tight timetable, they say. Another new rule with which the firm’s clients must comply, form PF, requires managers to send reams of data to the SEC on a regular basis.

“We have lots of clients that have lots of different systems — back office, front office, risk systems,” says Deak Jaros, and form PF requires managers to pull data from all of these systems to distribute to regulators and investors.

As a result, accounting firms like Ernst & Young are compiling “data warehouses,” as Deak Jaros terms them, to store information, including regulatory assets under management, risk data and firmwide financial figures. This ensures that the financial data being distributed by hedge fund firms to regulatory bodies and investors is centralized, consistent and vetted by accounting professionals before being subject to regulatory scrutiny. In addition, accounting firms make sure their hedge fund clients have a process to govern the handling of that data.

Deak Jaros says these rules have translated into a big uptick in demand from hedge fund clients for accounting services. Ernst & Young’s vast size allows it to tackle this added business, she adds. “From an expertise standpoint our regulatory practice has grown,” she explains. “We have responded to the needs of the markets by making strategic hires — including former regulators — into our advisory practice to help hedge fund managers navigate the environment.” Deak Jaros says that added value comes from the diversity of perspectives Ernst & Young’s experts provide. The accounting firm has 175,000 professionals operating in more than 150 countries, and its hedge fund practice manages about 40 percent of the global market share of hedge fund clients.

PwC, the world’s second-biggest accounting firm, with annual gross revenue exceeding $32 billion and nearly 9,600 partners worldwide, is popular with hedge fund firms of all sizes.

“Even though we are a very small client to PricewaterhouseCoopers, we receive the same high-quality service and attention of larger clients,” one hedge fund professional puts it. “PricewaterhouseCoopers is very good at keeping us informed throughout the year about new developments in the industry and new rules that apply to us.”

Revenue from the London-based firm’s North American and Caribbean offices surged more than 7 percent last year. This perhaps reflects hedge fund managers’ growing demand for information and guidance in complying with new U.S. regulatory laws, such as Dodd-Frank and the Foreign Account Tax Compliance Act, which aims to curb global tax evasion by requiring institutions based outside the U.S. to report information about U.S. clients.

This rise in demand is reflected in the rankings: Hedge fund professionals rate Audit as the most important of the five aspects of service, followed by Tax, Hedge Fund Expertise, Regulatory & Compliance and Client Service. Revenue from PwC’s tax and advisory services soared a combined 12.5 percent in the 2013 fiscal year.

Clients are quick to praise the firm in all five categories of this ranking. According to one hedge fund professional, PwC has “an efficient audit process whereby managers and senior managers are heavily involved in moving the audit process along. If issues arise, audit partners are available to provide guidance on a timely basis.”

Hedge fund clients praise third-place KPMG, which also ranks No. 2 in Tax, No. 3 in Hedge Fund Expertise and Regulatory & Compliance and No. 4 in Client Service, for its unparalleled understanding of the ever-changing markets. According to one enthusiast, the Amsterdam-based accounting firm “has the best client service, with full access to global experts.”

Global chairman Michael Andrew works from Hong Kong. This makes him the first chairman of a Big Four firm to be based in Asia and signals the growing importance of the region in international markets. In fact, KPMG enjoyed 16.3 percent revenue growth in India in its fiscal year ended September 2013, and 10 percent growth in revenue in China. Overall the Asia-Pacific region generated $3.9 billion in revenue for the company. The fourth-biggest accounting firm in the world, KPMG grossed $23.4 billion in total revenue for the 2013 fiscal year — a nearly 4 percent rise from the previous year.

Andrew has helped manage the firm in various leadership roles for nearly three decades and was elected global chairman in May 2011. Since then KPMG has opened five new offices worldwide and grown its overall workforce by 17,000 professionals. James Suglia was recently appointed national leader of the firm’s investment management sector in the U.S. Previously, he doubled the revenues for his department as U.S. advisory leader for investment management.

The KPMG name alone “carries a lot of weight,” says one happy client. Notes another, “Their services are very good, as one would expect from a Big Four firm.”

Fourth-place EisnerAmper, a smaller accounting outfit based in New York with a strong North American presence, doesn’t have the name recognition of a Big Four firm, but it still managed to beat out BDO, the world’s fifth-largest accounting firm, and Deloitte, the biggest of them all, in the Alpha Awards ranking this year.

Partners at EisnerAmper find themselves working more and more with emerging hedge fund managers. Nicholas Tsafos, audit partner at the firm, estimates that, given new compliance and due-diligence processes and complex tax structures, it takes three to five times as long to launch a hedge fund today as it did before the crisis. Requirements from legislation such as the Jumpstart Our Business Startups, or JOBS, Act, in the U.S., which was signed into law on April 5, 2012, are slowing the start-up process, he explains. New managers must concentrate on building out their infrastructure to get institutional investors comfortable with investing in them.

Despite this onus, the number of new fund launches has not fallen, Tsafos observes. As a smaller firm relative to its Big Four competitors, with just 1,200 employees, EisnerAmper has held its own amid growing demands from its ballooning hedge fund client base. One client notes that despite the increased traffic and the relatively modest size of its accounting team, “EisnerAmper was very timely in getting K-1 [tax forms] to investors.”

Fifth-place BDO garnered similar praise from its clients. “BDO USA provides timely and accurate audits,” says one, referring to the Chicago-based U.S. arm of BDO, whose global network has 56,000 partners and professional staffers in 144 countries.

The BDO International global network is significantly smaller than the accounting armies of its Big Four counterparts, but the firm consistently maintains its spot as the fifth-largest accounting firm in the world. Global revenue for the firm surged 7.3 percent last year, to $6.5 billion. Wayne Berson, chief executive of BDO USA and chairman of the global board of BDO International, has overseen the addition of 500 employees to BDO USA since his election as CEO in 2012.

Accountants and hedge fund managers agree that size matters for everybody. To maintain profit margins that are increasingly under pressure from new and expensive compliance measures, hedge funds need to muster up more money. “There is a limited amount of capital coming from existing clients, as institutional investors are not looking to drastically increase their allocation in hedge funds,” says Ernst & Young’s Deak Jaros. Funds are therefore soliciting new investments by attracting different types of investors, diversifying products and strategies and introducing customized services.

As the biggest hedge fund firms grow, they are turning to the larger accounting firms to help them stay on top of the demands they face in an increasingly regulated world. Hedge fund managers rely on the help of accountants to restructure their businesses to operate more efficiently in compliance with more-stringent rules. “Data management is a big issue for hedge fund managers today, as there’s an enormous amount of data going to the SEC on a regular basis,” says Deak Jaros.

“Our services have always been important,” she adds. “But they became more critical when the industry suddenly had to be ready to report to regulators.”

HOW WE COMPILED THE RANKINGS
Institutional Investor’s Alpha compiled the 2014 Alpha Awards ranking of top prime brokers, hedge fund administrators, law firms and accounting firms based on voting from last fall and early winter by some 500 hedge fund firms, including many in the 2013 Hedge Fund 100, our ranking of the world’s 100 largest hedge fund firms. Hedge funds were asked to rate the quality of service they received for the 12 months ended August 31, 2013, across a variety of attributes. The scores were weighted according to a voting firm’s assets under management and then averaged for each service provider within each attribute. In the accompanying tables we rank only those firms for which we received a minimum number of responses. To be considered for the overall ranking, prime brokers needed to rank in at least seven of the ten prime brokerage attributes; administrators needed to rank in at least five of the nine hedge fund administration attributes; law firms needed to rank in at least four of the six law firm attributes; and accounting firms needed to rank in at least four of the five attributes. The Alpha Awards survey was conducted by Senior Research Editor Jane B. Kenney.