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Report Recommends Review of Valuation Policies as Prosecutors Target Hedge Funds, Private Equity Firms

A report by CMRA, a risk management and consulting firm, discusses recent enforcement actions against hedge funds that mispriced their portfolio holdings and recommends valuation policy strategies for firms. In May, Bloomberg also reported on hedge funds facing U.S. criminal probes for allegedly seeking bogus prices from brokers in order to inflate the value of securities in their portfolios. In addition, U.K. regulators are scrutinizing hedge funds and private equity firms with complex and hard-to-sell investments. According to a U.K. news service report, at least three well-known hedge funds and one private equity firm have been targeted by the Financial Conduct Authority in recent months with requests to see their valuation policy documents. The CMRA report discussed recent SEC actions against asset managers regarding their valuation policies and procedures and in light of those enforcement actions recommends that firms:

  • Update written policies and procedures to reflect new transaction types, new data sources, and “lessons learned” from others’ mistakes.
  • Ensure that written policies and procedures reflect the firm’s actual practices. 
  • Implement a pricing process that results in a documented set of challenges and revisions, with any adjustments to pricing source inputs/outputs in writing.
  • Back-test actual new transactions vs. “marks,” and validate both third-party and proprietary valuation models for accuracy and reliability.
  • Maintain a database of broker quotes, pricing service data, screenshots, etc. for less liquid instruments and regularly review volume trends, discrepancies between pricing sources, and bid/offer spreads