A hedge fund manager agreed to pay disgorgement, investor reimbursement, fines and interest for mis-valuing portfolio securities and thereby collecting inflated management fees. According to the SEC, the fund manager relied almost exclusively on a third-party pricing service to value municipal bonds. The pricing service significantly over-priced securities by failing to include observable inputs such as broker quotes. Over the course of at least 2 years, the actual sales prices of bonds were significantly less than their stated valuations. As a result, the fund manager overstated fund NAVs, which caused an overpayment to redeeming shareholders and inflated management fees. The SEC faults the firm for failing to value the municipal bonds in accordance with GAAP (ASC 820) and good faith, as described in its Valuation Policy, financial statements and disclosure documents.
OUR TAKE: Fair valuation requires a determination of the price that would be received between market participants. A fund manager cannot slavishly rely on a third party pricing service especially if the prices result in an ongoing pattern inconsistent with actual transactions.