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By: Brian Hooven, Joshua Newville, Proskauer

A recent action where the SEC focused on the presumably conservative undervaluation of assets suggests that it is more than willing to use valuation as a hook to deter "smoothing" of returns. As we previously noted, while the SEC consistently announces that valuation is a "key area of focus," it is uncommon for regulators to second guess valuation determinations in the absence of other potential violations. However, failure to adhere to stated valuation policies/procedures is one situation that may lead to heightened regulatory exposure and disputes.

Earlier this month, the SEC announced a settled action against Deer Park Road Management Company, LP, a hedge fund that focuses on distressed securities (in particular, pre-2008 residential mortgage-backed securities). The SEC's order focused on two technical violations:

• Failing to adopt and implement reasonably designed compliance policies and procedures relating to valuation of fund assets; and
• Failing to implement its existing valuation policies.

First, the SEC argued that Deer Park's valuation policies and procedures weren't reasonably designed because they lacked procedures detailing how to use the market inputs available to Deer Park that were relevant to RMBS assets held by its flagship fund. Consequently, the SEC concluded that these procedures did not promote consistency or mitigate the potential conflict of interest from traders valuing the secu......................

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