SEC Charges Business Development Company and Officers for Overvaluing Assets During Financial Crisis (with Lofchie Comment)

The SEC charged a business development company (BDC) and three of its officers 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).

According to the order, the BDC's valuation procedures should have been consistent with the requirements of FAS 157, which prioritizes market value over other measures of value. Instead, the fund had treated all of its securities as illiquid, notwithstanding that many of the securities did trade, and valued the securities based on whether the funds' officers believed the fund was likely to be repaid in full.

KCAP Financial, Inc.'s (KCAP) overvaluation and internal controls failures violated the reporting, books and records, and internal controls provisions of the federal securities laws - Sections 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Exchange Act, and Rules 12b-20, 13a-1, 13a-11, and 13a-13 thereunder. Furthermore, the Order states that three of the officers caused KCAP’s violations and directly violated Exchange Act Rule 13b2-1 by causing KCAP’s books and records to be falsified. The Order also states that two of the officers also directly violated Exchange Act Rule 13a-14 by falsely certifying the adequacy of KCAP’s internal controls.

Lofchie Comment: Although the fund in question happens to be registered under the Investment Company Act, the valuation issues and procedures discussed in the order would be relevant to many private funds as well, and should be reviewed by anyone with responsibility for the conduct of valuations or authority as to sign-off on financial statements.

View Order in full here (links externally to SEC website).See also: Press Release