SEC Charges Fund Executives with Overvaluing Assets During Financial Crisis

The SEC charged three top executives at KCAP Financial Inc., a publicly-traded fund being regulated as a business development company (BDC), with overstating the fund’s assets during the financial crisis. The fund’s asset portfolio consisted primarily of corporate debt securities and investments in collateralized loan obligations (CLOs).  This is the SEC’s first enforcement action against a public company that failed to properly fair value its assets according to the applicable financial accounting standard — FAS 157 — which became effective for KCAP in the first quarter of 2008. The three executives agreed to pay financial penalties to settle the SEC’s charges.

According to the SEC, KCAP Financial Inc. did not account for certain market-based activity in determining the fair value of its debt securities and certain CLOs. KCAP also failed to disclose that the fund had valued its two largest CLO investments at cost. KCAP’s chief executive officer Dayl W. Pearson and chief investment officer R. Jonathan Corless had primary responsibility for calculating the fair value of KCAP’s debt securities, while KCAP’s former chief financial officer Michael I. Wirth had primary responsibility for calculating the fair value of KCAP’s CLOs. Wirth, a certified public accountant, prepared the disclosures about KCAP’s methodologies to fair value its CLOs, and Pearson reviewed those disclosures. 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.