The SEC charged a private fund manager and its principals with using a non-standard valuation model to value structured notes, thereby inflating fund performance and fees. The main principal launched his firm out of his college dorm room initially to invest his family’s fortune but ultimately marketed his fund to third-party investors. Rather than value the underlying structured note investments pursuant to “fair value” as required by ASC 820, the firm used a proprietary valuation model that deviated significantly from industry norms, thereby inflating returns and fees. The SEC asserts that the respondents lied to investors, the auditor, and the SEC staff about its valuation practices. The SEC cites multiple violations of the Securities Act, the Exchange Act and the Advisers Act.
Although ASC 820 leaves some discretion to management, the inputs cannot consistently juice valuations and returns and must have some market-based support. The SEC could preempt these types of practices by publishing more specific valuation guidance as previously promised.