The SEC brought administrative actions against three executives at a business development company (BDC) with overstating the BDC’s assets during the financial crisis. The BDC’s portfolio consisted primarily of corporate debt securities and investments in collateralized loan obligations (CLOs). A BDC is a type of investment company registered with the SEC.
The SEC found that KCAP Financial Inc. (“KCAP”), the adviser to the BDC, did not account for certain market-based activity in determining the fair value of its debt securities and certain CLOs. KCAP, according to the SEC, also failed to disclose that the BDC had valued its two largest CLO investments at cost. KCAP’s chief executive officer and chief investment officer had primary responsibility for calculating the fair value of KCAP’s debt securities, while KCAP’s former chief financial officer had primary responsibility for calculating the fair value of KCAP’s CLOs.
The SEC stated that KCAP did not record and report the fair value of its assets in accordance with Generally Accepted Accounting Principles (GAAP) and in particular FAS 157, which requires assets to be fair valued based on an “exit price” that reflects the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date. The SEC found that the executives concluded that any trades of debt securities held by KCAP in the fourth quarter of 2008 reflected distressed transactions, and therefore KCAP determined the fair value of its debt securities based solely on an enterprise value methodology. However, this methodology did not calculate or inform KCAP investors of the FAS 157 “exit price” for that security. Wirth calculated the fair value of KCAP’s two largest CLO investments to be their cost, and did not take into account the market conditions during that period.
According to the SEC, KCAP in May, 2010, restated the fair values for certain debt securities and CLOs whose net asset values had been overstated by approximately 27% as of December 31, 2008. Moreover, KCAP’s internal controls over financial reporting did not adequately take into account certain market inputs and other data.
Click http://www.sec.gov/litigation/admin/2012/34-68307.pdf to access the administrative action.