Fair Value Fraud

by: Belvedere

With the Enron trial in full swing, the issue of its abuse of fair value accounting for power contracts is bound to flare up in the press. Oddly coincidental timing: there’s a much less visible trial coming involving fair value reporting, one that I think crystallizes many of the accounting issues of the past few years - fair value reporting, poor internal controls, and auditing reform. Bear with me.

A few days ago, on February 9, the SEC instituted administrative proceedings against a PWC audit partner for letting the manager of three hedge funds overstate the fair value of convertible bonds in the portfolios.

The hedge funds (Lipper Convertibles, L.P., Lipper Convertibles Series II, L.P. and Lipper Fixed Income Fund, L.P.) were managed by one Edward J. Strafaci. From at least 1998 to January 2002, Strafaci provided intentionally overinflated values for convertible bonds and convertible preferred stock held by the three funds. There’s no question about this issue: Strafaci ‘fessed up, pleaded guilty, and is now serving a 72-month prison sentence and must pay $89 million in restitution.

These were not inconsequential amounts, if you were a partner in these vehicles. When restated as of the end of 2000, the partners’ capital in the “Convertibles