SEC Issues Compliance Alert About Sloppy Valuation Process
Hat tip to fellow blogger gal Wendy Fried for news about the recent release of an important ComplianceAlert, issued by the U.S. Securities and Exchange Commission. Click to read "Sloppy subprime valuations on Wall Street?..." (footnoted.org, July 25, 2008)
According to the SEC website, a ComplianceAlert letter highlights results of examiners' audits in an attempt to "encourage" institutions to better their current compliance and supervisory efforts. In its July 2008 letter that starts "Dear Chief Compliance Officer," the SEC staff provides a laundry list of concerns, including, but not limited to:
- Inadequate monitoring of personal trading by advisory staff
- Weak oversight of mutual fund boards to "confirm that the proxy service providers' recommendations were consistent with funds' policies and procedures"
- Stale valuations of high yield municipal bond fund holdings
- Poor or no disclosure of the increased valuation and liquidity risk when "the percentage of illiquid securities held by a fund dramatically increased"
- Questionable quality of price verifications of collateral held by certain broker-dealers
- Inexperienced staff who were nevertheless tasked to validate model prices
- Lack of documentation as to valuation standards relied upon by some broker-dealers.
The letter concludes with a variety of recommendations, including but not limited to:
- Improvement of price verification and assessment of "modeled inputs and the calibration of valuations against trades or trade information inferred from activity in similar securities and or the derivative markets"
- Retention of records "used in determining value"
- Getting independent product control groups involved in "monitoring collateral valuations"
- Creating and maintaining a database that "serves as the internal repository for security position information, including periodic valuations, in order to ensure consistency amongst various inventory trading accounts and collateral valuations."
I hate to say "we told you so" but this blog has been on a tear about proper valuation process for a long time. Check out a few of our many past posts.
- "Can You Spell 'Bad Valuation Practices'?" (June 3, 2008)
- "Missing Collateral = More Risk for Hedge Funds and Pension Plans" (December 24, 2007)
- "Pension Fiduciaries - Have You Asked Your Bankers About Their Risk Controls?" (November 5, 2007)
- "The Abracadabra of Valuation - Pension Fiduciaries Beware" (October 12, 2007)
With FAS 157 and international equivalent accounting rules forcing change, pension fiduciaries need to take a hard look at their external service providers' trading controls and valuation policies and procedures, if not already. Check with legal counsel but likely they will remind plan sponsors that delegation does not absolve one of the fiduciary duty to properly select and oversee vendors.
What is your biggest concern about how "hard to value" instruments are currently being assessed by banks and broker-dealers? Send us an email with your opinions.
