Valuation under scrutiny

The US Securities and Exchange Commission’s private equity investigations unit is examining how fund managers value assets, which some investors are applauding.

The US Securities and Exchange Commission has intensified its focus on private equity managers in an effort it says is to protect limited partners. One of the major issues the regulator will look at is how private equity managers are valuing their investments.

“Valuation is an issue we [are focused on] across the fund arena,” Bruce Karpati, co-chief of the SEC’s asset management unit, said at the PEI Private Fund Compliance Forum held in New York in May. “One of the issues we watch is whether third parties assessing valuations are truly independent.

Despite the fact that there is an independent party, we still need to scrutinise whether managers are accurately representing their valuation process

Bruce Karpati



“Despite the fact that there is an independent party, we still need to scrutinise whether managers are accurately representing their valuation process,” Karpati said.

The SEC will examine valuations even if they are audited, said Igor Rozenblit, a private equity specialist with the SEC’s asset management unit. “We are concerned with auditors’ scrutiny of valuations. Are you saying this company is valuable when it’s valueless?” Rozenblit said.

The way managers value their investments has been a concern among LPs, who worry in some cases that valuations are being inflated, especially when managers are trying to raise new funds. Exacerbating the issue is the dearth of information LPs get from managers about the values of portfolio companies, according to one LP.

“The way PE firms are set up, there’s a huge incentive to … push the level of what is reasonable,” the LP says. “It’s hard for LPs to really see if the valuations are right or not.” LPs are generally only given information about earnings before interest, taxation, depreciation and amortisation but don’t have access to balance sheets. “You could drive a truck through the difference between reality and what they’re providing,” the LP says about valuations.

Managers would be more likely to provide more accurate valuations with a regulator looking over their shoulder, the source adds.

However, some insiders remain sceptical the SEC would be able to effectively monitor and detect when managers were incorrectly valuing their investments unless they have staffers who have actually been involved in private equity deals in the past and know the process.

The SEC started to take a closer look at the private equity industry last year, when it created a team specifically to focus on the asset class. The investigative unit was formed in January 2010 and Karpati and Robert Kaplan, two of the commission’s veterans, were named to head the unit.

The SEC’s private equity team will also examine issues including side letters and preferential treatment of certain LPs over others.