Under the microscope: valuation and hedge funds

The current financial crisis revealed weaknesses in the US financial system, including the difficulty of valuing complex assets. This paper seeks to examine regulatory and compliance issues for hedge funds valuing complex assets.

Within the context of hedge fund valuation, the paper provides a general overview of: the regulatory background of hedge funds and the central role valuation plays in the operation and regulation of such funds; relevant cases brought by the SEC; and a discussion of valuation best practices.

Hedge funds are not “unregulated.” There is a body of law and accounting standards that applies to hedge fund valuation. Nevertheless, hedge fund valuation standards are evolving in this era of heightened regulatory scrutiny. The common concepts that have emerged from valuation best practices will likely provide the underpinning for any regulatory initiatives regarding hedge fund valuation.

By the time of publication, Congress may pass pending legislation governing hedge funds and there may be additional notable SEC cases on hedge fund valuation.

The economic crisis has revitalized the SEC's interest in this area. Consequently, hedge funds should consider adoption of a compliance program that specifically targets valuation by stressing investor disclosure, independence of the valuation function, comprehensive written valuation polices and procedures, and internal controls.

The paper compiles and organizes in one place the regulatory and compliance standards governing asset valuation by hedge funds.