by T. GormanPosted on Posted in SECActions

The SEC brought its first case centered on FAS 157, Fair Value Measurements. The provision requires expanded disclosures about fair value measurements. Essentially, it directs that assets be fair valued based on what is called an “exit price,” that is, a price that is based on what would be obtained if the asset were sold in an orderly transaction between market participants on a specific date.

The case centered on accounting during the market crisis at KCAP Financial, Inc., f/k/a/ Kohlberg Capital Corporation. The firm is a closed end investment company which elected to be regulated as a Business Development Corporation or BDC under the Investment Company Act. The company also has a subsidiary which manages CLO funds. Dayl Pearson is its President and CEO, Michael Wirth its CFO and R. Jonathan Corless the CIO. The firm and each of its three officers are named as Respondents in the action. In the Matter of KCAP Financial, Inc, Adm. Proc. File No. 3-15109 (Nov. 28, 2012).

From late 2008 through the middle of 2009 KCAP held two primary classes of assets. One was corporate debt while the other was investments in CLOs. During the financial crisis, according to the Order, the firm did not account for certain market based activity in determining the fair value of its debt securities. It also did not account for certain market based activity for its two largest CLO investments by properly fair valuing them. At the time KCAPs filings stated that those CLOs were valued using a discounted cash flow method that incorporated market data. In fact the CLOs were valued at KCAP’s cost.

In May 2010 the firm disclosed that it had to restate the fair values for certain securities and the CLOs. It had overstated NAV by about 27% as of the end of 2008. Its internal controls also were not designed to properly value illiquid securities. As a result, the Order alleges that the firm violated Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) and the related rules. The individual defendants are each alleged to have caused the violations.

To resolve the action each Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order. In addition, Messrs. Pearson and Wirth each agreed to pay a penalty of $50,000 while Mr. Corless will pay a $25,000 civil penalty.

Hurricane Sandy: As we enjoy the holiday season please remember the victims of Sandy’s destruction with a donation to the Red Cross (here).

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by T. GormanPosted on Posted in SECActions

The SEC prevailed in a pair of litigated cases this week. First, in SEC v. EagleEye Asset Management, LLC, Civil Action No. 11-CV-11576 (D. Mass.) a jury returned a verdict in favor of the Commission and against registered investment adviser EagleEye Management and its sole principal Jeffrey Liskov based on a fraud on the advisory clients. Second, in SEC v. Greenstone Holdings, Inc., Civil Action No. 10-cv-1301 (S.D.N.Y.) the court granted in part the Commission’s motion for summary judgment, fining attorney Virginia Sourlis liable for aiding and abetting a fraud by issuing a false legal opinion.

The complaint in EagleEye Asset Management centered around a forex trading scheme. Between April 2008 and August 2010 Mr. Liskov made material misrepresentations to a dozen clients, according to the Commission. The representations were made to induce the clients to liquidate their securities holdings and use the cash to engage in high risk forex trading. The trades resulted in about $4 million in losses for the clients but generated over $300,000 in performance fees. In some instances Mr. Liskov used a strategy which resulted in short term profits to generate the fees. Later, however, the positions would decline sharply in value.

In the case of two clients Mr. Liskov liquidated their brokerage accounts without permission. He then transferred the proceeds to forex trading accounts where virtually all of their money was lost. The transfers were done by doctoring the documents. The complaint alleged violations of Exchange Act Section 109b) and Advisers Act Sections 206(1), 206(2) and 204. See also Lit. Rel. No. 22546 (Nov. 27, 2012).

In Greenstone Holdings the Commission claimed that attorney Sourlis authored a false legal opinion that was used by the firm to issue over six million shares of unregistered stock. The opinion described notes, note holders and communications with those note holders for which there was no basis in fact.

In ruling in favor of the Commission the Court concluded that Ms. Sourlis claimed to have spoken to note holders who do not exist and that for several other representations in the legal opinion there was no factual basis. Accordingly, the Court found that Ms. Sourlis aided and abetted violations of Exchange Act Section 10(b). The Court reserved ruling on the Securities Act Section 5 claim against the attorney while rejecting the SEC’s claim of primary liability against Ms. Sourlis. The Commission plans to file a motion seeking appropriate remedies. See also Lit. Rel. 22542 (Nov.. 26, 2012).

Hurricane Sandy: As we enjoy the holiday season please remember the victims of Sandy’s destruction with a donation to the Red Cross (here).

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