FAS 157

FAS 157

FAS 157 Implications & Notes

The hedge fund industry has significant concerns with recent best practices recommended by the President's Working Group on Financial Markets regarding the disclosure of the valuation of managed assets centered on FAS 157 fair value accounting. In a letter to the Working Group, the Managed Funds Association said that the ambiguities of fair value accounting work against achieving a consensus on proper valuation of a hedge fund’s portfolio assets. The MFA also noted that the recommended disclosure goes beyond the requirements of FAS 157.

The Working Group issued complementary sets of best practices for hedge fund managers and investors in the most comprehensive effort yet to increase accountability for participants in the industry. The Working Group called on hedge fund managers to adopt comprehensive best practices in the critical areas of disclosure, valuation of assets, risk management, and conflicts of interest. Specifically, the Working Group said that fund managers should provide financial information supplementing FASB Standard No. 157 to help investors assess the risks in the valuation of the fund's investment positions.

Depending upon the extent to which the fund manager invests in illiquid and difficult-to-value investments, noted the Working Group, the disclosures should occur at least quarterly and include the percentage of the fund's portfolio value that is comprised of each level of the FAS 157 tripartite valuation hierarchy. Level 1 is comprised of assets with highly liquid market prices, while Level 2 assets have no quoted prices but there are similar assets with quoted prices. Level 3 is for illiquid assets that have to be priced using models.

The group also said a best practice would be to set up a Valuation Committee with ultimate responsibility for reviewing compliance with the fund manager's valuation policies. Further, the group said that independent personnel should be in charge of the valuation of the fund's investment positions. While broadly agreeing that investors would benefit from disclosure of hedge fund valuation policies, the MFA noted that there is much ambiguity and a lack of consensus among managers, counterparties and accounting professionals as to the appropriate treatment of a number of products under FAS 157 such that the Working Group’s recommendations may not be achievable. Further, the lack of consensus is likely to result in inconsistent disclosure across the industry, which could be both confusing and potentially mislead investors.

Thus, until a greater consensus exists with respect to implementation of FAS 157, the MFA asks that this recommendation be deleted. The MFA noted that fund managers will still be required by their independent auditors to follow the procedures specified in FAS 157, as the industry continues to develop consensus on the implementation of those procedures.

The committee also recommended that hedge fund managers disclose the percentages of a fund’s portfolio value for which a manager relied on one dealer quote and multiple dealer quotes. The MFA believes that this disclosure could also be misleading to investors since there are certain types of products for which one dealer quote is used in valuing the asset, even though there is a liquid and deep market for the product, such as certain types of OTC products. There may also be products for which multiple quotes are available, but for which there is not a particularly liquid, active and deep market. While the availability of multiple dealer quotes may be an indication of the level of market activity for an asset, said the MFA, it may be misleading in certain instances. As such, the group was urged to delete this recommendation.

While agreeing that the valuation function should be independent of the portfolio
management function in order to reduce conflicts of interest, the MFA believes that
the recommendations are confusing when read in conjunction with the make-up of the proposed Valuation Committee. The Working Group said that the Valuation Committee may include members of senior management who have portfolio management responsibilities. However, the recommendations also discuss segregation of valuation personnel from portfolio management personnel. To the extent that a Valuation Committee is partially comprised of senior portfolio managers, reasoned the MFA, then the desired segregation of personnel does not seem possible.

Guest post by James Hamilton

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