The Securities and Exchange Commission (SEC) charged three top executives at a New York-based publicly-traded fund being regulated as a business development company (BDC) with overstating the fund’s assets during the financial crisis.
The fund’s asset portfolio consisted primarily of corporate debt securities and investments in collateralized loan obligations (CLOs).
An SEC investigation found that KCAP Financial Inc. did not account for certain market-based activity in determining the fair value of its debt securities and certain CLOs.
KCAP also failed to disclose that the fund had valued its two largest CLO investments at cost. KCAP’s chief executive officer Dayl W. Pearson and chief investment officer R. Jonathan Corless had primary responsibility for calculating the fair value of KCAP’s debt securities, while KCAP’s former chief financial officer Michael I. Wirth had primary responsibility for calculating the fair value of KCAP’s CLOs.
Wirth, a certified public accountant, prepared the disclosures about KCAP’s methodologies to fair value its CLOs, and Pearson reviewed those disclosures.
Pearson and Wirth will each pay a $50,000 penalty and Corless will pay a $25,000 penalty to settle the SEC’s charges.
KCAP and the three executives, without admitting or denying the findings, consented to the SEC’s order requiring them to cease and desist from committing or causing any violations or any future violations of these federal securities laws.
Pearson was represented by John Carroll of Skadden in New York.
Corless was represented by Andrew Geist of O’Melveny and Myers in New York.
Wirth was represented by Gregory Bruch of Willkie Farr in New York.
And KCAP was represented by Walter Ricciardi of Paul Weiss in New York.
“When market conditions change, funds and other entities must properly take into account those changed conditions in fair valuing their assets, said associate SEC enforcement chief Antonia Chion. “This is particularly important for BDCs like KCAP, whose entire business consists of the assets that it holds for investment.”
The case represented the first SEC enforcement action against a public company that failed to properly fair value its assets according to the applicable financial accounting standard – FAS 157 – which became effective for KCAP in the first quarter of 2008.
“KCAP should have accounted for market conditions in the fourth quarter of 2008 in determining the fair values of its assets,” said Julie M. Riewe, Deputy Chief of the SEC Enforcement Division’s Asset Management Unit. “FAS 157 is critically important in fair valuing illiquid securities, and funds must consider market information in making FAS 157 fair value determinations and comply with their disclosed valuation methodologies.”