The Securities and Exchange Commission has 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. failed to 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. 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 charges made by the SEC.
KCAP and the three executives 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. Associate SEC Enforcement Chief Antonia Chion had this to say:
When market conditions change, funds and other entities must properly take into account those changed conditions in fair valuing their assets. 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. Julie M. Riewe, Deputy Chief of the SEC Enforcement Division’s Asset Management Unit, had this to say about the accounting standard:
KCAP should have accounted for market conditions in the fourth quarter of 2008 in determining the fair values of its assets. 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.
It’s good to see the SEC taking action to make sure that public companies comply with applicable laws.
Source: Corporate Crime Reporter
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