Fund Manager’s Valuation Policies

Fund Manager’s Valuation Policies

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Recently at the National Regulatory Services’ 28th annual Spring Investment Advisor & Broker-Dealer Compliance Conference in Ft. Lauderdale, Florida, Michael Caccese of K&L Gates and Christopher Mears of Rothstein Kass presented their perspective of “Meeting SEC Expectations for Private Fund Evaluation.” They commented that the use and consistency of modeling for valuation of level three assets is one of five main areas that fund managers should focus on to meet SEC compliance expectations.

Asset manager compensation is typically tied to the value of the assets they manage. Bruce Karpati, Chief of the Asset Management Unit’s division of Enforcement said recently in a speech, “The temptation to overvalue assets to boost compensation has emerged repeatedly in enforcement cases. The AMU is focused on detecting fraudulent or weak valuation practices – including lax valuation committees … and the failure to follow a fund’s stated valuation policy.” The SEC is focusing on the investment managers’ use of modeling to determine estimated fair value of level three investments. Level three investments are those investments that are typically very illiquid and are valued using unobservable inputs, as opposed to level one assets which are valued on open markets, such as publically traded stocks and mutual funds. To the extent that an investment advisor uses an analytical method or pricing model to value their level three assets, valuation policies developed by the investment advisors should describe the following: the circumstances in which it employs the model, the methods or models it uses, the basis for the models, and the process for reviewing the reliability of the models.

We also recommend that our clients use multiple methods to determine fair value of level three assets including historical cost, discounted cash flow and the direct capitalization method. We also recommend that our clients document their rationale for the amount that each method is weighted to determine the ultimate value.

We believe this is a best practice because it provides documented support that the investment advisor reviewed several models and had a rationale for how the final value was determined. Additionally, it provides a level of assurance that the investment advisor is not overvaluing the assets, which would consequently boost management fees, by documenting the range of possible values from the different models and where on the spectrum management has determined the applicable fair value.

The presentation at the Investment Advisor & Broker• Dealer Compliance conference concluded with a listing of the presenters’ recommendations for best practices to be employed for private fund valuation to meet SEC expectations:

  1. create a culture of compliance within the firm with robust supervision and internal controls
  2. ensure that appropriate checks and balances exist where employees have overlapping or conflicting positions (e.g. a portfolio manager valuing a fund’s assets)
  3. implement a compliance program tailored to the risks of the firms’ investment strategy
  4. test and verify valuation procedures, particularly with respect to complete or illiquid assets

If you would like to discuss how valuation policies may impact your business or obtain additional information, please contact the Keiter Financial Services team at (804) 747-0000.

About the Author

Keiter CPAs is a certified public accounting firm serving the audittax, accounting and consulting needs of businesses and their owners located in Richmond and across Virginia. We focus on serving emerging growth businesses and companies in the financial servicesconstructionreal estatemanufacturingretail & distribution industries and nonprofits. We also provide business valuations and forensic accounting servicesfamily office services, and inbound international services.

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The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.


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