New York Securities Lawyer Blog
On Monday, March 30, 2015, the Securities and Exchange Commission (“SEC”) filed an Order Instituting Administrative Cease-and-Desist Proceedings (“Order”) against Patriarch Partners, LLC, Patriarch Partners VIII, LLC, Patriarch Partners XIV, LLC, Patriarch Partners, XV, LLC (collectively “Patriarch Partners”), and CEO Lynn Tilton (“Tilton”), alleging that Tilton and Patriarch Partners breached their fiduciary duty to investors. The SEC charges arise out of the concealment of poor performance of loan assets in three Collateralized Loan Obligation (“CLO”) funds, while improperly collecting approximately $200 million in fees. The SEC’s Order may be accessed here.
As defined in the Order, “[a] CLO fund is a securitization vehicle in which a special purpose entity, the issuer, raises capital through the issuance of secured notes and uses the proceeds to purchase a portfolio of commercial loans. A collateral manager, typically an investment adviser, determines what loans to purchase or originate on behalf of the CLO fund. Cash flows and other proceeds from the collateral are used to repay the investor noteholders in the CLO fund.”
The Order alleges that since 2003, Patriarch Partners and Tilton have defrauded customers through three (3) CLO funds, collectively known as the “Zohar Funds,” by providing false and misleading information relating to the performance and values of these funds. The Zohar Funds raised more than $2.5 billion from investors and used the capital to make loans to distressed companies. However, these distressed companies were found to have made only partial payments or no payments at all against the loans, and have performed poorly over the last few years.
Additionally, per the CLO funds’ documents, Patriarch Partners was required to regularly provide information to investors regarding valuation categorizations of assets and financial statements reflecting each funds’ financial position, for which a borrower’s default on interest payments is considered. However, Patriarch Partners failed to change the valuations when the distressed companies defaulted on their payments. Instead, Patriarch Partners would only choose to lower valuation categories for an asset if Tilton subjectively decided to withdraw her support for the company, a methodology which they withheld from investors. The SEC alleges that had Patriarch Partners and Tilton complied with their duties, the valuation categories would have revealed failed investments as early as 2009 and investors would have saved approximately $200 million in management fees, which were billed at a rate of 1% of the amount of assets every quarter.
The SEC’s Director of Enforcement, Andrew Ceresney, stated that Tilton “violated her fiduciary duty to her clients when she exercised subjective discretion over valuation levels, creating a major conflict of interest that was never disclosed to them.”
As a result of the alleged misconduct, the SEC is charging Patriarch Partners and Tilton with violations of Sections 206(1), 206(2), and 206(4) of the Investment Advisers Act of 1940 (“Advisers Act”), which state, “[i]t shall be unlawful for any investment adviser, by use of the mails or any means or instrumentality of interstate commerce, directly or indirectly— (1) to employ any device, scheme, or artifice to defraud any client or prospective client; (2) to engage in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client; … or (4) to engage in any act, practice, or course of business which is fraudulent, deceptive, or manipulative.” The SEC is also charging Patriarch Partners and Tilton with violation of Rule 206(4)-8 of the Advisers Act, which prohibits fraudulent conduct in pooled investment vehicles.
Lax & Neville LLP has extensive experience in successfully prosecuting claims on behalf of customers who have suffered losses. Please contact our team of attorneys for a consultation at (212) 696-1999.