Ok, I had to come back. All this talk of me lying on some beach in the Caribbean is all wrong. After I got back from San Diego, I became buried in audits. I did pass Bob’s office and, as I suspected, his feet were up on the desk as he was listening to some Springsteen.
I am still swamped auditing hedge funds, mutual funds, exchange traded funds and private equity funds. The mutual funds and exchange traded funds are much less complex than the other two as these are publicly traded and thus the underlying investments are typically long position securities traded on an active market. Valuation is as simple as looking up the price on an independent pricing source, such as Bloomberg.
Where the agita comes in is the valuation of the underlying assets of some hedge funds and private equity funds. A private equity fund invests in private companies with the hopes that the companies will mature and either go public or get purchased by a larger company, and then the Fund can cash out with large profits. Until the ultimate sale of a portfolio company occurs, the Fund investment manager must value these portfolio companies. The auditors must then determine whether or not these values are materially correct.
One might think that there is a high risk of overstating values and earnings in Fund reporting. Usually, the Fund is paid a management fee based on asset value and an incentive fee based on profits, so the higher the value/earnings, the higher the fee. In performing an audit we assess a high risk that the valuations are overstated and if there have been write downs of value, an auditor usually sleeps easier at night.
However, the risk may change from overstating value to understating value depending on the stage of the private equity fund. This occurs when a fund is past its predetermined termination date and is in the wind-down phase; the investors want their money but the Fund cannot sell the portfolio companies. Here, the Fund management may want to report lower values so that if an investor forces the Fund to buy them out, the Fund will pay off at a lower value. In the future, the fund can sell the portfolio company at a much higher value and pocket the difference. This is an auditor’s nightmare. Understanding the stage and the risks are extremely vital to performing an effective and proper audit.
This is what I have been struggling with the past two weeks while Bob has been writing this blog. He thinks my life as an auditor is so easy, but all he has to do is put numbers on the right line on a tax return.
Take that “Mr. Bobbing to the Beat”!