Investment advisers are a continuing focus of SEC Enforcement. During the last government fiscal year actions involving investment advisers and firms were the second largest category of cases. Indeed, the trend in recent years has reflected increasing numbers of actions involving investment advisers.
The Commission’s most recent case in the area is SEC v. Direct Lending Investments LLC, Civil Action No. 2:19-cv-218 (C.D. CA. Filed March 22, 2019). Direct Lending is an unregistered investment adviser owned by Brendan Ross. The firm serves as the adviser for two feeder funds and a master fund. Direct Lending is solely responsible for the management of those funds. The California based advisor is not registered with the Commission.
The advisor purchased loans, participations in loans and credit facilities. Clients were charged a management fee of 1% of the master fund’s gross asset value. A performance fee was also charged when the net asset value of the master fund exceeded its prior high net asset value and was calculated as 20% of those earnings before interest and taxes. In communications with investors the advisor repeatedly touted its strong, consistent returns. Returns of 10% to 12% were claimed with no down months.
QuarterSpot was a key investment for the adviser. The New York based firm was an on-line lender. In late September 2017 the adviser sold about $55 million of its QuarterSpot holdings to an investment vehicle operated by a business associate of Mr. Ross who guaranteed the transaction. The deal essentially cut Direct Lending’s QuarterSpot holdings in half. Nevertheless, the adviser remained involved in processing loan information for QuarterSpot loans.
Beginning in 2014, and continuing for the next four years, Mr. Ross knew about difficulties with the QuarterSpot loan portfolio from the available loan data. During that four year period he sought to conceal those issues and urged the company to manipulate its results. Those efforts are reflected in a series of communications involving Mr. Ross and the company. This resulted in the falsification of QuarterSpot payment information. That in turn caused the adviser to materially overstate the value of its position in the company by about $53 million between 2014 and 2017. As a result, the adviser collected about $11 million in excess fees.
By late 2018 certain borrower payment data on the advisors’ books did not match that of QuarterSpot. By early 2019 QuaerterSpot representatives refused to respond to questions on the subject.
In February 2019 the advisor announced that the Funds had suspended withdrawals and redemptions because one of its largest counterparties ceased making payments on a significant loan. The next month Direct Lending announced that another position – QuarterSpot—may have been materially overstated for a period of years. Mr. Ross resigned after being requested by the management committee to take a leave of absence. The complaint alleges violations of Advisers Act Sections 206(1), 206(2) and 207, Exchange Act Section 10(b) and Securities Act Section 17(a).
The advisor consented to the entry of a permanent injunction based on the sections cited in the complaint. The firm also agreed to the appointment of a receiver. The complaint seeks additional relief. See Lit. Rel. No. 24432 March 25, 2019).