AICPA puts pressure on LPs for fair value, speed

Recent guidance by the American Institute of Certified Public Accountants (AICPA) is intended to help in the determining of the fair value of investments, but they may also push GPs to be more proactive in reporting to their investors.

Late last month the AICPA published a set of technical practice aids relating to the Financial Accounting Standards Board’s Accounting Standards Update 2009-12, which allows an investor to use net asset value reported by the general partner to estimate the fair value of an alternative investment, provided certain criteria are met. Among such conditions is a need for the GP to actually produce net asset value based on the fair value of their underlying investments, and that net asset value be the same measurement date as the LP’s own financial statements (known as “in phase” reporting).

In providing guidance to determine whether net asset value is fair-value based, the AICPA’s practice aids (which can be found at: http://www.aicpa.org/download/news/2009/TIS_Section_2220_Long-Term_Investments.pdf) cover a number of factors that will be taken into account, such as: Did the GP use the services of a third-party valuation expert to validate the fair value that they are using in net asset value? Are the underlying securities publicly traded or illiquid? What’s the reputation of the auditor?

For limited partners, this will mean more thorough documentation in assessing the rigour applied by the general partner in coming to fair value. “What this AICPA guidance clearly says is that LPs have to have policies and procedures to make a determination that the general partner has given them a rigorous, developed fair-value-based NAV, and it must be in phase, and if it is not then the guidance says there are things you can do to either rehabilitate net asset value, or things you should do to come up with fair value if you are not going to use net asset value,” said David Larsen, managing director at Duff & Phelps.

Often this will likely mean that if LPs don’t have the internal staff to do these things, they will have to either hire a third-party or reevaluate whether they have the resources to invest in alternatives.

“I think fundamentally, from a governance point of view, every investor is responsible for the use of fair value assertions in their own financial statements, and they cannot abdicate that role,” Larsen said. “They can use third parties to assist them, but they cannot abdicate that fundamental governance role that they are responsible for the estimates in their own financial statements. Many LPs do the due diligence and the ongoing monitoring, but they may not have documented it or it may not have been rigorous to provide a basis for conclusion, and that’s where there needs to be improvement.”

On the GP side, this opens the door for certain funds to attract more investors by demonstrating that they not only use third parties but that they can also deliver information on a more timely basis. While currently GPs have 90 to sometimes 120 days to report, in the future that timeframe may have to come down to 30, 10, or perhaps even five days.

“That’s where the real pressure is going to come – on timing,” Larsen said. “General partners are going to have to do a better job in delivering timely reports because that is what the AICPA guidance says. If I’m a large insurance company and I have to close my books on 10 days after the quarter ends, the guidance says I have to have NAV that’s in phase. So if my general partner does not deliver – and there are virtually no general partners that deliver in 10 days today – then the LP has to do more work. So a general partner who starts reporting in 10 days all of a sudden takes that work away from the LP.”

Trying to speed up their reporting timeframes may seem daunting for funds already trying to do more with less right now. But in the competition for limited investment dollars, it can put GPs at the top of list in the eyes of investors.