On March 30, 2015, the SEC announced fraud charges against Patriarch Partners, LLC, its CEO, Lynn Tilton, and its related entities, each a manager of certain collateralized loan obligation funds, for allegedly failing to value assets using the methodology described to investors in the offering documents of the funds. Such practices, the SEC alleges, resulted in the overpayment of management fees and other payments to the Patriarch entities of almost $200 million.

According to the SEC, the funds raised more than $2.5 billion in capital by issuing secured notes and used the proceeds to issue loans to distressed companies. The SEC states that despite the poor performance of many of these companies, the valuation of the loans remained unchanged. Contrary to the impairment categorizations called for in the fund documents, the SEC alleges that Ms. Tilton exercised subjective discretion over valuation levels, creating a major undisclosed conflict of interest and violation of her fiduciary duty to her clients.

Specifically, the SEC alleges that Ms. Tilton, who makes significant decisions relating to the management of each fund’s collateral, has consistently and intentionally used her own discretion to determine how an asset is categorized. Rather than determining loan impairment following the specific criteria outlined in the fund documents relating to the collection of interest and principal when due, the SEC alleges that Ms. Tilton maintained an asset’s valuation category unless and until she decided that she would no longer “support” the portfolio company (i.e., she would cease to provide financial and managerial support). The SEC notes that certain portfolio companies have failed to pay as much as 90% of the interest owed to the funds, yet such loans remain in the highest valuation classification. In addition, the SEC alleges that the financial statements of the funds are false and misleading for failing to be prepared in accordance with U.S. GAAP, as the fund documents require and Ms. Tilton has certified. As a result of the foregoing, the SEC has charged Ms. Tilton and the Patriarch entities with various counts of fraud under the Advisers Act and breach of her fiduciary duties to her clients.