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Portfolio valuations: Auditors off the hook

The precise responsibility of parties such as accountants and administrators in the event of hedge fund portfolio valuation discrepancies has been of growing concern among service providers.

As more hedge funds are forced to liquidate hard-to-value assets, auditors and administrators’ handling of valuations is under scrutiny. A court win by Ernst & Young in New York, however, has provided some relief to accountancy firms at least.

In 2002, Beacon Hill Master hedge fund, having lost about $300 million, was charged with inflating the value of its mortgage-backed securities portfolio. Denying wrongdoing, managers settled the case in 2005 for $4.4 million.

However, when liquidators attempted to reclaim the lost millions, they targeted auditor Ernst & Young, alleging that the firm had performed a deficient audit that contributed to the fund’s collapse. In July, however, a New York judge, Charles Ramos, ruled that Ernst & Young was not liable for the downfall of the fund. The liquidators also sued the fund’s administrator, ATC Fund Services, which settled.

Possible precedent

The case will perhaps set a precedent for the handling of accusations of blame that are certain to arise as more hedge funds are forced into liquidations from bad investments that have emerged in the credit crunch. Where accountants or administrators will be held responsible, however, is if it is proved that they knew of wrongdoing or deliberate inflation of valuations by hedge fund managers.