In this three-part series, experts address valuation-related issues with investment funds, including applicable rules, best practices, and lessons learned from recent enforcement actions.

March 13, 2018

Stout recently hosted a conference in Atlanta discussing issues, trends, and best practices related to valuation. The panel focused on recent enforcement actions with private funds and featured the following panelists:

  • Jesse R. Morton, Stout, Dispute Consulting Director & Southeast Forensic Services Leader
  • Jamie Spaman, Stout, Valuation Advisory Managing Director
  • Matt Rogers, Stout, Dispute Consulting Director & National SEC and Accounting Practice Leader
  • Peter Anderson, Eversheds Sutherland, Partner
  • Jody Foster, Symphony Consulting LLC, President
  • Kevin Brawner, Trident Fund Services, Senior Manager

The panel addressed a series of topics including:

  • Why valuation is an enforcement priority for regulators
  • Common valuation related issues
  • Valuation related accounting rules, regulations, and guidance
  • Best practices policies, procedures, and processes for valuing Level III assets
  • Fund administrator roles and responsibilities
  • Preparing for an audit or regulatory examination
  • Key takeaways from recent valuation related issues and enforcement actions

The following is the third installment of our review of a recent expert panel discussion on enforcement actions involving private funds. In this third installment, the panel discusses the impact of a recent enforcement action, how a fund can best prepare for an audit and regulatory examination, and how funds can best avoid regulator scrutiny of their valuation process. See the first installment for the panel discussion on why valuation is an enforcement priority for regulators, common valuation related issues, and relevant accounting guidance, and the second installment for the panel discussion on best practices around valuing Level III assets and the benefits of using an independent third-party valuation specialist.

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Explanation of the Impact of the Visium Asset Management Enforcement Action.

In the SEC enforcement actions related to Visium Asset Management (“Visium”), one of the allegations related to two portfolio managers, Christopher Plaford and Stefan Lumiere, of manipulating the valuation of certain securities held by one of their funds.[1] Specifically, the fund disclosed to investors that it would use “fair value” to price assets, and the fund administrator would value those assets using established pricing sources. Instead, however, Plaford and Lumiere frequently overrode the fund administrator prices with “[their] own, hand-picked, sham quotes, which were U-turned through friendly brokers.”[2] The scheme resulted in the fund overstating its performance and over-charging investors nearly $6 million in management and performance fees.

Brawner indicated there were several “red flags” that stuck out in the Visium actions, including:

  • They were trading in bonds and distressed debt and yet the firm outsourced valuation to the administrator
  • The fund’s valuation policy called for use of a pricing service but best practice is to ask the pricing service to provide the pricing information to the administrator directly
  • Their policy allowed for overriding of pricing, which although not uncommon as there are reasons why that might occur, they were overriding the prices on an average of 35 prices a month and over 300 in a year – i.e., they were asking the administrator to override more than 10% of their portfolio which is very uncommon
  • They were asking the administrator to override prices with increases that were as much as 35%
  • They were consistently deviating from their valuation policies
  • They were getting pricing from the same “friendly” brokers
  • They were only overriding the valuations to increase the price, and never decrease

Brawner stated that, from an administrator perspective, these “red flags” should have started a discussion as to why they were deviating from policy, what justified the frequent deviations, and why their valuation policy remained unchanged despite the frequent deviations.

Anderson reminded the audience that in cases like Visium, there are serious consequences to valuations that are intentionally misstated. In Visium, Judge Rakoff, Senior U.S. District Judge for the Southern District of New York, sentenced one of the portfolio managers to 18 months in prison. The incentive for obtaining the sham quotes was getting higher management fees and, presumably, higher bonus compensation, but the consequence was going to jail.

What Is the Best Way That a Fund Can Prepare for an Audit and/or Regulatory Examination (as It Relates to Valuation), and What Are Some Recent Focus Areas?

Foster provided initial insights based on her experiences working with several funds, and stated that the following are the best ways to prepare for a regulatory exam:

  • Have a written response to regulator questions and requests
  • Provide a response in a timely manner
  • The response should clearly show what factors went into the valuation process
  • Provide documentation to support the pricing information and/or quotes that were received
  • The response should be complete and address all questions asked and information requested
  • The fund should keep track of relevant legal cases and enforcement actions, and incorporate key findings and takeaways into their process
  • At the completion of each exam, share with the fund manager what the regulators liked versus did not like
  • Research “best practices” in the industry and consider whether they should be incorporated into the fund’s own process
  • Make sure everything is documented – regulators tend to be tougher on firms when there is a lack of documentation
  • Critically review the valuation committee charter, the make-up of the committee to make sure there is not a perception of conflicts (i.e., a majority of members who are incentivized by higher valuations), and ensure there are complete and adequate notes and meeting minutes

Anderson noted that he has been very public for several years about the SEC traditionally not challenging actual valuations, but rather the absence of a written process and firm not following the agreed upon process. In August, however, the SEC challenged the actual valuation in the aforementioned KPMG/John Riordan matter where the SEC believed that the valuation was inflated and unrealistic based on the facts and circumstances. Anderson noted, despite the KPMG enforcement action which he considered an ‘outlier’, when a fund has a valuation policy that is well documented, the process is disclosed to investors, and the fund follows the process documented in the policy, it is extremely unlikely that the SEC will challenge a valuation and ultimately bring an enforcement action. Additionally, Anderson stressed the importance of the following:

  • Consistently apply valuation procedures, and not deviate from those procedures
  • Do not routinely override valuations obtained from third-parties and/or those calculated internally using the established process in place
  • All individuals in the valuation process should have a general understanding of the inputs that go into valuing Level III assets – that should especially include the CFO, portfolio managers, and directors – and be able to articulate that general understanding to the fund’s auditor and to regulators

Rogers chimed in to provide a slightly different perspective as a former auditor, regulator, and forensic accountant who typically sees ‘bad actors.’ He observed that one of the biggest obstacles that auditors face is the inherent conflict between exhibiting professional skepticism with their client yet being hired and paid by that client and wanting to retain that business. Accordingly, it frequently makes it tough for auditors to ask the tough questions and to continue asking for documentation and support to meet professional standards that appropriately substantiates management’s assertions and validates their claim.

What Are Some Key Takeaways From Recent Enforcement Actions and/or Insights on How Funds Can Avoid Scrutiny From a Regulator?

Rogers and Anderson focused the discussion on the KPMG/John Riordan matter, where Miller Energy paid $4 million to assume certain property rights in Alaska but later reported them in the financials as having a value of $480 million. Both noted that the sheer increase in price between what was paid and what was claimed raised a red flag to the SEC, and the failure on the part of the auditors to identify and question that valuation and obtain sufficient evidence to support the increase.

Anderson noted that the SEC, in the enforcement action, identified a series of other red flags including a “lack of common sense” (i.e., a lack of professional skepticism) which he noted was ‘typical’ in SEC actions involving auditors. Anderson emphasized the importance of reasonableness and making sure that the valuations fundamentally make sense. He also noted that in the KPMG/John Riordan matter there seemed to be “one foot fault after another” in the audit of Miller Energy. Anderson also pointed out that Miller Energy sought to raise money in the public markets which directly relates to the SEC’s function – to protect investors, especially where the company fails shortly after.

Anderson briefly discussed the case, SEC v. Ken Alderman, et al., from June 2013, which was brought as a result of the market distress from 2007-2008 and related to six Morgan Keegan funds. In that case, the SEC brought charges against eight directors of the funds who were ultimately censured as part of a settlement. While lawyers had drafted the valuation related policies and procedures, the main issue in the case was that the directors did not understand, or attempt to understand, the policies, procedures, or process that were implemented by the funds. Anderson noted that in the Consent Order the SEC detailed the responsibilities of the various parties surrounding valuation, and when the parties could rely on information provided.

Finally, there was a question from the audience as to whether there had been any enforcement actions related to the understatement of the valuation of assets. Rogers noted that the SEC has traditionally been focused on the issue of overstatement rather than understatement, however, the SEC will also raise questions where an asset is carried at a low amount but at the time of sale there is a “large” mark-up. He went on further to state that in such a scenario the regulators may believe that that fund is creating a “cookie jar” type reserve, especially when the fund is otherwise performing well relative to the market. Brawner indicated that assets should be valued based on what is occurring in the market, so the valuation of assets should go up and down accordingly – not merely moving in one direction.

Last, Morton reminded that audience that valuation not only needs to be performed on hard-to-value assets, but also liabilities. Accordingly, a lot of the risk of understatement relates to liabilities more than assets – that is, understating a liability.

See the first installment for the panel discussion on why valuation is an enforcement priority for regulators, common valuation related issues, and relevant accounting guidance, and the second installment for the panel discussion on best practices around valuing Level III assets and the benefits of using an independent third-party valuation specialist.


  1. SEC v. Platford (2016), SEC v. Lumiere (2016), SEC v. Valvani and Johnston (2016) (collectively, the Visium cases)
  2. Vincent Pitaro, “SEC Continues to Focus on Insider Trading and Fund Valuation,” The Hedge Fund Law Report, June 30, 2016.

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