It should come to no surprise that alternative funds have an extra level of scrutiny when it comes to valuations. RD Legal Capital is under scrutiny by the Securities and Exchange Commission according to a story in the Wall Street Journal.
RD Legal is in litigation finance with a strategy to to buy stakes in a judgment at a discount to the likely settlement. The firm bankrolls lawsuits hoping to collect if damages are paid. It took a big stake in a lawsuit against Iran, buying claims at a steep discount.
Apparently RD Legal has been writing up the value of that stake even though no settlement has been paid.
Valuation, whether right or wrong, is more subjective when it comes to illiquid assets. Real estate fund managers and other alternative fund managers are aware of this. The fairness question and therefore the regulatory question is what the effect of the valuation is on the investors and the fund manager. If the fund manager can take an extra fee on unrealized gains, the valuation should be subject to extra scrutiny.
The SEC is accusing RD Legal of taking cash at the expense of investors based on the increased valuation.
I fear the outcome will be one based on hindsight. If the settlement gets paid, the increased valuation will be justified. If it never appears, then the firm will be subject to even greater scrutiny.
Sources:
- Wall Street Cops to Hedge Funds: Treat Investors Better By ROB COPELAND and ARUNA VISWANATHA in the Wall Street Journal
- Hedge Fund That Bet on Bombing Judgment Takes Early Payouts: RD Legal Capital collects millions before award is issued, while telling investors to wait until ‘illiquidity’ issues pass
- Measuring by Jonathan Khoo CC BY NC SA