Last week’s item on the hedge fund industry—and potential new business opportunities for valuation specialists—prompted a note of concern from some leaders in the profession. “Valuation practitioners should assess business risks before accepting a new engagement,” says Mike Crain (FVG International). “Performing valuations of assets owned by hedge funds has business risks for appraisers that are different from those of valuations for other reasons,” such as tax, financial reporting, and litigation. “If a hedge fund goes bad, investors might file a lawsuit against anyone involved with the fund,” Crain warns, “including the appraisers who valued its assets. In these cases, investors and a bankruptcy trustee will look at anyone who has ever touched the hedge fund and still has money in order to try to recover damages.”
Case (almost) in point: In Maxwell v. KPMG (March 21, 2008), the bankruptcy trustee claimed over $600 million in damages against the Big Four auditors, for approving an allegedly inflated income statement prior to a dot.com merger (which later went bad in the 2001 economic bust). The U.S. District Court tossed out all the claims—and the Seventh Circuit affirmed, dismissing not only the suit but the supporting valuation by a financial analyst, which it called “outlandish.” (An abstract of the Maxwell case appears in the May 2008 Business Valuation Update™.) Thus the words of warning could cut both ways. Many have predicted a securities litigation boom in the wake of Sarbanes-Oxley, the credit crisis, and the current economic bust. (See BVWire #66-4). Valuation specialists will want to subject any new assignment in these emerging but potentially volatile areas to sound risk management policies and procedures.