Hedge funds compliant with the Employee Retirement Income Security Act may have to use an independent valuation service or disclose their methodology, lawyers said. The U.S. Department of Labor, which regulates ERISA compliance, is concerned hedge fund advisers receiving performance fees may manipulate the valuation of fund assets to influence the size of those fees, they said. The DOL expects the advisers receiving performance fees to seek independent valuations.
For the DOL, the issue is whether the hedge fund adviser and its affiliates have the power to determine their own compensation, said Ira Bogner, partner at Proskauer Rose in New York. If an adviser is seen to be using valuations to influence performance fees, it is deemed by the DOL to be self-dealing and committing a prohibited transaction, said David Pickle, partner at Kirkpatrick & Lockhart Nicholson Graham in Washington, D.C. The issue comes to the forefront where fund assets do not lend themselves to easy valuation, said Pickle. Hedge fund advisers managing plan assets, whose strategy involves illiquid securities, should ideally use an independent appraiser to value illiquid assets, said Bogner. But if the adviser performs the valuations, it may be possible to develop a methodology that eliminates discretion, he said.
The methodology should be disclosed to investors, who could be provided the opportunity to challenge the valuations, Bogner said. Bogner said he has recently seen a slight increase in the number of hedge funds moving toward ERISA compliance, but most choose to keep their amount of benefit plan assets below the 25% threshold, which allows them to avoid ERISA compliance.