Written by: Jay B. Gould
On December 12, 2013, the Securities and Exchange Commission (SEC) charged a London-based hedge fund adviser and its former U.S.-based holding company with internal controls failures that led to the overvaluation of a fund’s assets and inflated fee revenue for the firms. The investigation came out of the SEC’s Aberrational Performance Inquiry, pursuant to which the Enforcement Division’s Asset Management Unit identifies suspicious performance through risk analytics. The SEC searches for performance that is inconsistent with a fund’s investment strategy or other benchmarks and then conducts follow up inquiries. In this case, the SEC worked with the United Kingdom’s financial regulator, the Financial Conduct Authority.
According to the SEC’s order instituting settled administrative proceedings, the GLG firms managed the GLG Emerging Markets Special Assets 1 Fund. From November 2008 to November 2010, GLG’s internal control failures caused the overvaluation of the fund’s 25 percent private equity stake in an emerging market coal mining company. The overvaluation resulted in inflated fees to the GLG firms and the overstatement of assets under management in the holding company’s filings with the SEC.
The SEC order also stated that GLG’s asset valuation policies required the valuation of the coal company’s position to be determined monthly by an independent pricing committee. On a number of occasions, GLG employees received information calling into question the $425 million valuation for the coal company position. The SEC found that there were inadequate policies and procedures to ensure that such relevant information was provided to the independent pricing committee in a timely manner or even at all. There also appeared to be confusion among GLG’s fund managers, middle-office accounting personnel, and senior management about who was responsible for elevating valuation issues to the independent pricing committee.
The SEC’s order found that GLG Partners L.P. violated and GLG Partners Inc. caused numerous violations of the Federal securities laws. It also required the GLG firms to hire an independent consultant to recommend new policies and procedures for the valuation of assets and test the effectiveness of the policies and procedures after adoption. The GLG firms agreed to pay disgorgement of $7,766,667, prejudgment interest of $437,679, and penalties totaling $750,000.
The SEC has been targeting valuation cases recently as evidenced by the recent enforcement action against the Morgan Keegan fund directors and in the Ambassador Capital case. Fund managers should review their valuation policies and procedures to make sure that such policies and procedures address current regulatory concerns, and to make sure that the disclosures in their fund documents are consistent with actual practice.