Transcript Duff & Phelps - Malta Financial Services Authority

Key Accounting & Audit Issues for
Investment Companies
MFSA CPDC for Directors of Investment Companies
and Investment Funds
February 17, 2015
1.
Accounting & Auditing from the
Investor Perspective
LP Perspective – Accounting & Audit
• LP’s Expect:
– Transparency
– Consistency
– Rigor
– Compliance with Fund Formation Documents (Limited Partner
Agreement)
• Domicile & Sophistication of the LP will drive:
– Basis of accounting (IFRS/US GAAP)
– Frequency of reporting (Quarterly?)
– Reliance/Over-reliance on the Auditor
– Focus on Valuation
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Key Accounting/Audit Concerns
• Support for Valuation Estimates
• Applicability/Reliability of Broker Quotes/Third Party Prices
• Proper reporting and allocation of fees/expenses
• Clear calculation of performance fees
• Appropriate Disclosures
• Timely periodic reporting (generally quarterly)
• Same rigor included in valuation estimates and financial reports at all
reporting dates
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Why do/should LP’s care about Fair Value?
• Fair Value is the basis LPs use to report periodic (monthly/quarterly/yearly)
performance to their investors, beneficiaries, boards, etc.
• Fair Value is the best basis to make “apples to apples” asset allocation
decisions.
• Fair Value is an important data point in making interim manager selection
decisions on a comparable basis.
• Fair Value is often necessary as a basis to make incentive compensation
decisions at the LP level.
• Limited Partners need consistent, transparent information to exercise their
fiduciary duty. Fair Value provides such information on a comparable basis for
monitoring interim performance. An arbitrary reporting basis such as cost does
not allow comparability.
• Most investors, including retirement funds, are required by relevant GAAP to
report their investments on a Fair Value basis.
• Investment Companies (under IFRS & US GAAP) are exempt from
consolidation rules because their investments are carried at Fair Value.
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Fair Value Definition has Aligned!
Fair Value is defined by:
• FASB ASC Topic 820 (fka SFAS 157),
• IFRS 13, and
• Proposed GASB Standard (US Government Accounting Standards
Board)
as:
… the price that would be received TO SELL an asset or paid to
transfer a liability in an ORDERLY transaction between market
participants at the measurement date. (emphasis added)
Key Considerations:
•
•
•
•
•
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Unit of Account
Calibration
Market Participant Assumptions
Orderly transaction
How does Value Accrete?
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Board’s role with respect to Valuation
• Tone at the top
• Ensure consistent overall valuation policy (compliance with IPEV Guidelines)
• If AIFMD regulated, ensure independence in valuation process
– Use of Independent Valuer does not eliminate ultimate responsibility
• Final responsibility for final Fair Value conclusions (quarterly?)
– Reliance on management/deal teams/external valuation advisors, etc. is
expected
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Best Practices for Valuing Direct Investments
• Valuation analysis completed regularly (quarterly?)
– Responsibility
• Investment Manager / Finance Team
• Independent valuation expert (in concert with internal valuation)
– Approaches (Enterprise Value)
• Precedent transaction of subject company or related securities
• Qualitative assessment; to adjust value from latest market transaction
• Discounted cash flow / Probability Weighted Expected Return Method
• Market approach (M&A deals, publically traded comparable firms)
– Allocation of enterprise value to classes of securities
• Liquidation – Waterfall
• Fully diluted ownership
• Option based analysis
– Multiple approaches used, if appropriate, and reconciled according to
meaningfulness and quality of inputs
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Best Practices for Valuing Fund Interests
No understanding of GP’s valuation process
Full understanding of GP’s valuation process
Strong
Weak
Blind acceptance
Assess and update
internal policies
Implement periodic
monitoring
• Use of NAV without • Diligence of Fund • Reliance on advisory
further review
Valuation Policy at
committee for Fair Value
entry
oversight
• Reliance on GAAP
reporting as
indication of good
Fair Value
• Review of
•
Investment
Managers
documented
Valuation processes
• Assumption that
appraisals provide
superior evidence
• Reliance on Auditor • Categorize Investment
for oversight
Manager’s process and
monitor accordingly
Increased transparency
and timeliness
• Confirm use of 3rd party valuation
advisor and understand scope of
work
Confirming Investment
• NAV is, as of reporting date or
Manager’s actual process
adjusted for events and market
with interviews and periodic
movement
questions
• Valuation Support Committee
formalizes process to address
issues or problem funds
• Evidence of Fair Value: 3rd party
reports, correlations to market
data, back-testing, IPEV
compliance
• Valuation details provided by
Investment Manager and
reviewed by PM or 3rd party
quarterly
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Questions for discussion
• Primarily Valuation Responsibility: Investment Teams vs Finance Teams?
• Source of valuation analytics/inputs?
• Portfolio Company Management vs Deal Team projections
• Extent inputs should be validated?
• Valuation Template
• Market approach vs Income Approach vs Cost Approach
• Weighting of approaches
• Source of inputs
• Other
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Divergence in Practice: Accounting & Auditing
• Unit of Account
• Actively Traded Securities
• Premiums/Discounts
– Control vs. Non-Control
– Marketability discounts
• Value of Debt used to determine the value of Equity
• Failure to Calibrate
• Option Pricing Models
• Conservatism
• Cross-holdings
• Blind acceptance of NAV
• Blind acceptance of Pricing Services
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Emerging Fair Value Questions
• Impact of Transaction Fees – How do they impact Fair Value?
– Various interpretations; Fair value should exclude transaction fees – for some this means:
• Day one loss; Purchase price is 100 of which 95 goes to seller and 5 goes to fees – Fair
value = 95
• Day one no impact: Transaction Value = Fair Value; Market participant would not pay 100 if
value was not 100.
• Day one double loss: Assuming seller incurs costs, fair value could be 95 minus 5 of seller
fees = 90
– Many GPs use option 2 above; some option 1; fewer option 3
• Legal and/or Contractual Restrictions for actively traded securities
– Facts and circumstances are key
– Legal or contractual restriction attributable to shares could justify a “discount”
– Diverse treatment of underwriters contractual lockups; likely should qualify for a discount, but
auditors often conclude that contractual restrictions would not transfer with the shares
• Unit of Account – IFRS The creation of “investment accounting” under IFRS raised questions as
to the appropriate unit of account
– Some Auditors concluded that IFRS required a “single share” (minority interest) view
– IASB exposure draft focuses on actively traded securities
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Emerging Fair Value Questions
• AICPA Private Equity / Venture Capital Taskforce
– Tasked with writing a guide on how to value PE/VC investments
– Arguably replicates what IPEV has done (different conclusions could be problematic)
– Heavy involvement by audit firms
– Draft guide not expected until 2015/16
• Use of Option Pricing (OPM) in Fair Value estimation
– U.S. AICPA “Cheap Stock” (Stock compensation) Guide encourages the use of OPM
– Market Participants do not generally use OPM, therefore not Fair Value
– Auditors (inappropriately) have applied the Cheap stock guide to PE/VC valuations;
the AICPA PE/VC taskforce was established because of such issues
– GASB Proposal implies need to use OPM
• Use of Real Estate Appraisals
– Appraisals are generally not cost effective for regular (quarterly) fair value estimates
– The purpose of an appraisal, the basis of valuation and the unit of account may not
be congruent with determining fair value for LP reporting purposes
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European Alternative Investor Fund Manager Directive (AIFMD)
• Inherent incongruence in AIFMD valuation requirements
– Need for independence in estimating Fair Value
– Yet, Fund Management (the GP) cannot abdicate their fiduciary duty to stand
behind the assertions in the fund financial statements
– But,
• there are certain specific rules that must be followed under AIFMD
• historical status-quo is not sufficient
• Enhancing the Valuation Process under AIFMD
– Valuation Input from Investment professionals remains critical
– Follow best practice valuation guidelines (IPEV)
– Ensure valuation process includes a level of independence
– Engaging an independent third party valuation expert to validate the AIFMs fair
value conclusions demonstrates objectivity and independence
– The use of a third party to validate the AIFMs fair value conclusions has been
embraced by limited partners globally and is considered ‘best-practice’
• UK FCA Proposed Independent Valuer Guidance
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Questions and Contact Information
David L. Larsen
Managing Director
345 California Street
Suite 2100
San Francisco, CA 94104
+1 415 693 5330
[email protected]
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David L. Larsen, CPA, CGMA
Managing Director, Alternative Asset Advisory Services
David Larsen is a managing director in the San Francisco office of Duff & Phelps and part of the Portfolio
Valuation service line. He has more than 30 years of transaction and accounting experience. He specializes in
valuation, accounting, and regulatory issues faced by Alternative Asset managers and investors.
Duff & Phelps, LLC
San Francisco
+1 415 693 5330
[email protected]
David advises leading Private Equity Managers and Institutional Investors and has advised numerous strategic
and private equity acquirers in all areas of mergers, acquisitions, joint ventures, divestitures and valuation
related maters. He serves as a board member of the International Private Equity and Venture Capital Valuations
Board (IPEV), which in 2012 released updated International Private Equity Valuation Guidelines and issued new
Investor Re[porting Guidelines; and serves as a member of the American Institute of Certified Public
Accountants (AICPA) PE/VC Practice Guide Task Force. David has served as a special advisor to the
Institutional Limited Partners Association; board member, project manager and technical advisor to the Private
Equity Industry Guidelines Group and was instrumental in developing and drafting the Private Equity Industry
Guidelines Group’s Valuation and Reporting Guidelines; member of the Financial Accounting Standards Board’s
Valuation Resource Group responsible for providing the Board with input on potential clarifying guidance on
issues relating to the application of the principles of FASB ASC Topic 820 (formerly SFAS No. 157), Fair Value
Measurements and a member of the AICPA Net Asset Value Task Force.
Prior to joining Duff & Phelps, David was a Partner in KPMG LLP’s Transaction Services practice, where he was
the segment leader of KPMG’s U.S. Institutional Investor practice. He served 13 years in KPMG’s Seattle,
Düsseldorf and Prague audit practices prior to moving full time to deal work.
David received his M.S. in accounting from Brigham Young University’s Marriott School, his B.S. in accounting
from Brigham Young University. He is a certified public accountant licensed in California and Washington. David
is also a member of the AICPA and the California and Washington Society of Certified Public Accountants.
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Across a Range of Expertise
M&A advisory and capital raising services in the United States are provided by Duff & Phelps Securities, LLC. Member FINRA/SIPC. Pagemill Partners is a Division of Duff & Phelps
Securities, LLC. M&A advisory and capital raising services in the United Kingdom and Germany are provided by Duff & Phelps Securities Ltd., which is authorized and regulated by the
Financial Conduct Authority.
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Regulatory Affiliations
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locations and services, please visit:
www.duffandphelps.com
About Duff & Phelps
Duff & Phelps is the premier global valuation and corporate
finance advisor with expertise in complex valuation, dispute
consulting, M&A and restructuring. The firm’s more than 1,000
employees serve a diverse range of clients from offices in North
America, Europe and Asia.
M&A advisory, capital raising and restructuring services in the
United States are provided by Duff & Phelps Securities, LLC.
Member FINRA/SIPC. Pagemill Partners is a Division of Duff &
Phelps Securities, LLC. M&A advisory and capital raising
services in the United Kingdom and Germany are provided by
Duff & Phelps Securities Ltd., which is authorized and regulated
by the Financial Conduct Authority.