FSA and Iosco eye hedge fund fraud

Hector Sants, managing director of wholesale and institutional markets at the FSA, outlined the views of the UK’s financial watchdog in a letter to Dan Waters, chairman of the valuations subcommittee at the International Organisation of Securities Commissions (Iosco), a global network for financial regulators to share information and formulate policy on fraud.

Sants wrote that investment firms should ensure that fund managers do not influence the valuation of funds. This requires a separation of duties between portfolio managers and the back office, which may also include external monitoring from a third party and regular reconciliations with the prime brokers, banks that finance the hedge fund’s positions along with the administrator, wrote Sants.

“It is recommended that managers have procedures in place for the day-to-day operation of the pricing process. This document should be updated when the manager starts to use a new instrument/investment type that has significantly different characteristics from those in their current portfolio,” wrote Sants.

Philippe Richard, secretary-general of Iosco, told Risk News that the UK’s FSA was a “leading force” for improving the regulation of the burgeoning hedge fund sector. He said Iosco would carefully consider the FSA’s views on the valuation of hedge fund assets.

Richard said: “We are working on the issue of valuation and interviewing industry people, especially with regards to the valuation of illiquid instruments.”

Earlier this year, the FSA barred Jae Wook Oh, the chief executive of the London-based adviser Regents Park Capital Management, from working in the industry for three years after uncovering faulty valuations he made in 2005.

The importance of fund valuations and the need for robust independent valuation processes was highlighted by the FSA in a discussion paper, 05/4 Hedge Funds: A discussion of risk and regulatory engagement, published in March this year.

A spokesman for the FSA said London-based hedge fund managers were using third-party administrators based in Dublin – which are regulated by the Irish Financial Services Regulatory Authority - to obtain independent valuations.