Axiom Valuation’s AIRAS Immunizes Successful Hedge Funds from the SEC’s New Aberrational Performance Inquiry

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The Securities and Exchange Commission (SEC) has recently unleashed a powerful new screening tool, Aberrational Performance Inquiry (API), to identify possible fraudulent valuations and misreported returns by hedge fund managers reporting above benchmark returns. For a hedge fund seeking to avoid being subject to the SEC’s API process, Axiom Valuation’s AIRAS capability can protect the fund from a possible SEC API by demonstrating through a quantitatively robust and empirically defensible report that the fund’s self-reported returns match the fund’s strategies.

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The AIRAS approach has the advantage of being able to identify a Madoff-type fraud, where the reported returns were not above market benchmarks.

Last week’s SEC announcement of enforcement actions against three hedge funds and six individuals for misconduct including improper use of fund assets, fraudulent valuations, and misrepresenting fund returns, demonstrated a ground-breaking shift in the operating environment for hedge funds. These are the first actions brought by the SEC using their new API capability, which utilizes proprietary risk analytics to test hedge fund’s self-reported returns against the fund’s investment strategy or other benchmarks. For the first time, the SEC has an analytical and information advantage over the hedge funds it regulates. AIRAS returns the advantage to hedge funds that are accurately reporting their returns.

The SEC is casting a wide net across all hedge funds that are reporting performance of greater than 3% above market indexes, according to testimony by Robert Khuzami, Director of the Division of Enforcement for the SEC in March, 2011. This means that most successful hedge funds will be targeted for at least some degree of further scrutiny by the SEC’s API process. This scrutiny cannot be good news for hedge funds in terms of management time, legal costs, and reputational risk. In essence, these successful hedge funds are guilty until proven innocent.

Fortunately, Axiom Valuation has developed AIRAS, the only hedge fund return authentication capability, that for the last three years has been providing hedge funds and their institutional investors with exactly the information needed to satisfy the SEC that a fund is accurately reporting its returns – potentially before the API process even starts. AIRAS is the first product to deliver objective and empirical analysis based on established financial research and mathematical optimization of whether the return and NAVs reported by the manager are reported properly based on a manager’s reported investment allocations (by industry, by country, and by asset type). AIRAS provides an independent authentication of what the hedge fund managers are reporting – hence our slogan of “Trust But Verify”.

Axiom Valuation has been and continues to be a strong advocate for increasing transparency in the reporting of returns for alternative investments and for making the auditing process for institutional investors in alternatives more analytically driven. “We applaud the SEC for pursuing the use of analytical tools to more effectively screen for potential fraud and/or misreporting,” said Dr. Stanley Jay Feldman, the Chairman of Axiom Valuation and the principal architect of the AIRAS capability. Dr. Feldman also noted: “We have shared our approach and research with the SEC and with some major financial service companies as part of the effort to raise awareness of what the analytical possibilities are for identifying possible misreporting situations. The AIRAS approach has the advantage of being able to identify a Madoff-type fraud, where the reported returns were not above market benchmarks.”

AIRAS is the answer for hedge funds that want an independent authentication of their returns and their strategies that can be delivered to the SEC. AIRAS is also the answer for institutional investors and their auditors that want an independent and auditable report as to whether any of their alternative investments is a potential problem area in terms of misreporting or false reporting. AIRAS can reduce the number of hedge funds that the SEC needs to include in its API screening, thus allowing the SEC to concentrate more resources on the true problem funds.

Axiom Valuation is the global pioneer in developing rigorous analytical solutions to authenticate self-reported returns for alternative investment funds, where only the portfolio characteristics are disclosed, but the underlying investments are not. The company is also a leading financial security, illiquid asset, and business valuation firm specializing in the application of fair value for financial reporting purposes. Fair value pricing requires the use of analytical tools, acceptable financial models and highly trained market professionals who understand the idiosyncratic nature of market outcomes as these events relate to fair value.


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Dr. Stanley Feldman

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