SEC enforcement action acts as valuation processes reminder for credit funds

Overview of the enforcement action

According to the SEC’s order, the Adviser employed a “season and sell” strategy under which it originated senior loans and, after typically holding them for 30 to 60 days, sold portions of those loans to private funds it advised in principal transactions. Fund agreements and investor disclosures represented that such transactions would be priced at fair value as reasonably determined by the Adviser.

The SEC found that during the onset of COVID 19, the Adviser continued to price loan transfers using a mechanical formula (par value less unamortized loan fees) without reassessing whether market volatility and liquidity conditions affected fair value. The SEC concluded that this failure to reassess valuation rendered the Adviser’s practices inconsistent with its disclosures.

The SEC did not allege intentional misconduct. Instead, the action was premised on negligence based anti-fraud provisions, which is similar to another action we recently covered. This also reflects the SEC’s view that valuation methodologies should be actively reevaluated when market conditions materially change. Notably, the SEC indicated that all but one of the loans fully performed or were repaid.

Without admitting or denying the findings, the Adviser consented to a cease and desist order, censure, and $900,000 civil monetary penalty for violations of Sections 206(2) and 206(4) of the Investment Advisers Act of 1940 and Rule 206(4) 8 thereunder. The SEC did not seek disgorgement because in response to an SEC staff examination deficiency letter concerning the conduct, the Adviser voluntarily reimbursed the funds ($5,010,854.90, plus $203,819.69 in interest) as compensation.

Key takeaways

• Private credit managers should review their valuation policies and disclosures.
  • Valuation is a process, not a formula. The SEC emphasized that reliance on static pricing methodologies may be insufficient when market conditions materially change, particularly in affiliated transactions where conflicts are inherent.
  • Disclosures set the standard. Where governing documents and disclosures promise fair value determinations, advisers should consider whether contemporaneous practices reflect that commitment in substance, not merely in form. Advisers also should consider whether disclosures are aligned with practice not only in ordinary markets, but under stressed conditions as well.
  • Market stress heightens expectations. Periods of volatility, even if relatively brief, do not relax fair value obligations; they intensify them. Managers should expect the SEC to scrutinize whether valuation methodologies were reassessed in real time as market conditions evolved. An aggressive SEC may be willing to second guess an adviser’s valuation.
  • Third party consent is not a safe harbor. While the Adviser used third party review agents for principal transaction consent, the SEC’s case focused on valuation integrity rather than consent mechanics, underscoring that procedural compliance alone may be insufficient.
• Principal trades will likely be a focus. Principal transactions between advisers and affiliated funds remain a core enforcement priority. Valuation is often the lens through which the SEC evaluates whether conflicts were adequately managed.
• Negligence based cases remain a priority. This recent action continues a trend of SEC enforcement grounded in fiduciary duty and disclosure failures rather than scienter based fraud.
• Exams as a pipeline for enforcement. Examinations remain a key source of enforcement activity, particularly where disclosures and practices diverge.
• Remediation does not foreclose enforcement. The SEC’s willingness to seek an enforcement action and impose penalties despite post exam remediation reinforces that remedial measures, while important, may not eliminate enforcement risk if past conduct diverged from disclosures.