SEC probe highlights valuation challenges(3)

The need for documented valuation practices at private equity firms is one of a number of issues related to the SEC’s recent inquiries into the industry and reported investigation into a fund managed by Oppenheimer Holdings.

The US Securities and Exchange Commission and Massachusetts attorney general’s reported investigation into valuation practices at Oppenheimer Holdings may help accelerate the trend of private equity firms adopting more thorough, written valuation procedures.

Firms have already been ramping up documentation of their valuation methods in advance of the 30 March 2012 deadline to register with the SEC.

“The rigour of the process has been increased dramatically, knowing that the SEC is going to be looking over their shoulder,” said Jason Brown, partner at law firm Robes & Gray. “It’s now routine for private equity firms to adopt written valuation procedures, which were relatively uncommon among smaller firms.”

Brown was speaking on a panel discussion sponsored by advisory firm Houlihan Lokey on portfolio company valuations and the reported case being brought against Oppenheimer alleging the firm overstated the value of one of its portfolio companies.

Due to a lack of documented valuation procedures at private equity firms, the reported investigation into Oppenheimer will rely, in part, on informal documents, Brown added.

“One of the key pieces of evidence is email traffic regarding a mark-up in the value of the security,” he said.

The lack of standard policies governing documentation of valuation methods is just one of a number of issues relating to private equity valuation processes that have attracted increased scrutiny from the SEC.

“One of the problems, and it’s particularly acute, is…there are few, if any, established professional bodies who credit or regulate valuations,” technical director of the International Valuation Standards Council Chris Thorne said during the panel discussion. “A single lack of a recognized authority for valuations has also led to the FASB and the IASB to develop their own standards of valuations for accounting measurements, even though they’ve got no desire to be seen as valuation standard-setters.”

While the use of third party valuation firms to calculate valuations is one method firms have adopted in recent years to help validate independent analysis, the SEC will be scrutinising even those valuations that have been vetted by a third-party auditor.

“The situation of the private equity funds today seems like the situation hedge fund managers found themselves in several years ago with increased pressure from regulators and investors to become more transparent about valuation processes and procedures,” Houlihan Lokey managing director Cindy Ma said during the panel discussion.

Regardless of whether the SEC finds that private equity firms have been misleading investors by “marking up” valuations, the recent inquiries into private equity practices are unlikely to go away anytime soon.

“As more firms complete their registrations, I think we’ll likely see more of these informal inquiries,” said Brown.