The 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 case arose from the SEC’s Aberrational Performance Inquiry, an initiative by the Enforcement Division’s Asset Management Unit that uses proprietary risk analytics to identify hedge funds with suspicious returns. Performance that is flagged as inconsistent with a fund’s investment strategy or other benchmarks forms a basis for further investigation and scrutiny.
According to the SEC’s order instituting settled administrative proceedings, from November 2008 to November 2010, the firms’ 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 firms and the overstatement of assets under management in the holding company’s filings with the SEC.
According to the SEC’s order, 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, the firms’ employees received information calling into question the $425 million valuation for the coal company position. But 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 was confusion among the fund managers, middle-office accounting personnel, and senior management about who was responsible for elevating valuation issues to the independent pricing committee.