Adviser Charged With Fraud Tied to Valuations

The valuation of holdings and assets is a key issue for investment advisers and funds. Incorrectly valuing assets, for example, can over or understate the value of the fund and the fees charged clients. It can mislead shareholders regarding the value of their interest in the fund. Many investment advisers, accordingly, have specific policies which address the valuation of assets. That was the case in the Commission’s latest action involving an investment adviser. The policy, however, did not stop the adviser from manipulating the value of the funds. To the contrary the policy seemed to have facilitated it. SEC v. Ross, Civil Action No. 2:20-cv-07202 (C.D. CA. Filed August 11, 2020).

Defendant Brendan M. Ross is the founder and sole owner of Direct Lending Investments, LLC, a Commission registered investment adviser. The funds advised by Direct Lending use a master – feeder structure. A portion the over $800 million is assets under management were loans extended by QuarterSpot, Inc., a New York based maker of small business loans.

Mr. Ross focused on the return of the funds, frequently touting their strong historical performance in meetings with investors, materials regarding the funds and at other times. In the initial years of the operations the performance was fine.

In 2014 performance changed. QuarterSpot began having delinquencies. Under the terms of the firm’s valuation process those delinquencies required downward deductions in the valuation of the loans. As the delinquencies continued, the terms of the firm’s valuation policy required mark downs that should have been as much as 50% to 100% in some instances.

To address the delinquency question Mr. Ross began directing QuarterSpot, in early 2014, to rebate a portion of its servicing fees by making payments to the funds. Those payments were recorded to make it appear that in fact there were no delinquencies – the loans looked like they were current despite the fact that they were not. Thus, over a three-year period that continued to 2017, the funds’ value did not decline. To the contrary, during the period the value of the funds was overstated by about $53 million – returns were materially misstated. In addition, the management and performance fees were overstated by about $5 to $6 million. The reports filed with the Commission on Form ADV also reflected the falsely inflated values. The materials furnished to investors were the same – they reflected the false values.

The arrangements Mr. Ross made with QuarterSpot to inflate the valuations were concealed. Specifically, the arrangements were not disclosed to others at the advisory, the funds’ auditors or third parties. Indeed, when information regarding the scheme first surfaced, Mr. Ross denied the claims. Following an internal investigation which uncovered the wrongful actions Mr. Ross resigned in March 2019. The complaint alleges violations of Advisers Act Sections 206(1), 206(2) and 207 as well as Securities Act Section 17(a) and Exchange Act Section 10(b). The case is pending. See Lit. Rel. No. (August 11, 2020).