Valuation not litigation

In this period of heightened economic turbulence and uncertainty, we are witnessing a large number of hedge fund wind-ups, write Julian Korek and Malin Nilsson of Kinetic Partners LLP. One of the consequences has been an increased focus on valuation and liquidation of assets by all stakeholders in the investment management industry, especially illiquid and hard-to-value investments. This article will look at why valuation is increasingly important and at good practice valuation standards, which could prove an invaluable investigative defence against adverse scenarios or disputes. We will also examine the potential future developments in valuation.

Julian Korek may be contacted on tel: +44 20 7862 0802 / +1 212 661 2200; email:julian.korek@kinetic-partners.com.

Why is valuation suddenly high on the industry’s agenda?

Maybe the obvious answer to this question would be the current economic crisis, but increased scrutiny began some time ago. Regulators are homing in on governance around valuation, and numerous papers have been published on the subject (eg, the FSA Letter of Recommendations on Good Practices, published in November 2006 [1]). There is an acknowledgment that valuation is a key risk area, with many serious instances of frauds involving Net Asset Value (NAV) misstatement. The US Securities and Exchange Commission (SEC) has pursued ten cases per year in the last five years. In his speech at the Hedge 2008 Conference on 22 October this year, Hector Sants, FSA CEO recognised that “the current market environment increases the risk of mismarking frauds being perpetrated.” In the less sensational cases, there has been mis-valuation due to, for instance, lack of consistency in price sources. Last year, an academic study concluded that “smoothing” of valuations occurred in a significant minority of cases examined. Clearly, regulators see valuation as the key operational risk.