U.S. Treasury Wants Better Hedge Fund Disclosure

By Reuters

WASHINGTON (Reuters) – The U.S. Treasury Department wants hedge fund managers to improve disclosure of hard-to-value assets and adopt audited public company-style performance reports for investors, a summary of recommendations obtained by Reuters shows.

The Treasury Department did not propose any new regulation, but chose instead to rely on market-driven due diligence and improved disclosure. The Treasury on Tuesday [April 15] was due to release hedge fund best practices guides from two committees it commissioned last year – one for hedge fund managers and one for hedge fund investors.

They were among a number of steps that the Treasury-led President’s Working Group on Financial Markets recommended in September 2007 to protect investors and reduce systemic risks posed by the growth of hedge funds while not restraining financial innovation. The two committees started their work as financial market stress from subprime mortgage defaults were gathering steam, creating worries about investments made by the nearly $2 trillion hedge funds sector.

Among the thorniest problems in the global credit crisis is establishing valuations for largely illiquid mortgage-backed securities lodged on bank and hedge fund balance sheets. The Treasury group’s Asset Managers’ Committee, headed by Eric Mindich, chief executive of Eton Park Capital Management, calls on hedge funds to put in place more robust procedures for the valuation of assets, including written policies, segregation of responsibilities and other measures.

In its summary, it said this should specifically emphasize hard- to-value assets such as complex derivatives. New accounting standards will soon require financial institutions to categorize such assets in three levels based on how difficult they are to value.

“This report calls on hedge funds to implement these new standards, and then go beyond them, on a quarterly basis, the portion of their assets and profit (or loss) attributable to assets in each of the three levels,” the panel said in its summary. It also called on hedge fund managers to adopt key principles of the U.S. public company disclosure regime, including quarterly and annual reports, timely disclosures of material events, and audited financial statements compliant with accounting standards, “so investors get accurate, independently verified financial information.”

Hedge funds also need to put in place a system of checks and balances, such as a conflicts committee to resolve potential conflicts. It also said portfolio managers should be segregated from those responsible for valuing assets.

Right Investment?

A parallel report by the Investors’ Committee, headed by Russell Read, chief investment officer of the California Public Employees Retirement System, suggested questions that managers of pension funds, university endowment funds, trade unions and other fiduciaries should ask themselves before they invest in hedge funds. “Prior to embarking on a hedge fund program, fiduciaries should be satisfied that incorporating hedge funds into a portfolio would improve its risk and reward profile and increase the probability of meeting the applicable investment objectives,” the Investors’ Committee report noted.

According to the report, such fiduciaries should adopt written procedures for defining key features and objectives of a hedge fund investment program and for evaluating their own risk management practices. It also called on hedge fund investors to develop comprehensive philosophies regarding payment of fees and expenses for hedge fund managers based on the returns sought and the risks assumed by an investment strategy

Hedge funds “are not an asset class in the traditional sense. More than many other investment vehicles, hedge funds require in- depth and continuous oversight by their investors,” the panel said in the summary.

By David Lawder

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