The SEC brought its first case centered on FAS 157, Fair Value Measurements. The provision requires expanded disclosures about fair value measurements. Essentially, it directs that assets be fair valued based on what is called an “exit price,” that is, a price that is based on what would be obtained if the asset were sold in an orderly transaction between market participants on a specific date.
The case centered on accounting during the market crisis at KCAP Financial, Inc., f/k/a/ Kohlberg Capital Corporation. The firm is a closed end investment company which elected to be regulated as a Business Development Corporation or BDC under the Investment Company Act. The company also has a subsidiary which manages CLO funds. Dayl Pearson is its President and CEO, Michael Wirth its CFO and R. Jonathan Corless the CIO. The firm and each of its three officers are named as Respondents in the action. In the Matter of KCAP Financial, Inc, Adm. Proc. File No. 3-15109 (Nov. 28, 2012).
From late 2008 through the middle of 2009 KCAP held two primary classes of assets. One was corporate debt while the other was investments in CLOs. During the financial crisis, according to the Order, the firm did not account for certain market based activity in determining the fair value of its debt securities. It also did not account for certain market based activity for its two largest CLO investments by properly fair valuing them. At the time KCAPs filings stated that those CLOs were valued using a discounted cash flow method that incorporated market data. In fact the CLOs were valued at KCAP’s cost.
In May 2010 the firm disclosed that it had to restate the fair values for certain securities and the CLOs. It had overstated NAV by about 27% as of the end of 2008. Its internal controls also were not designed to properly value illiquid securities. As a result, the Order alleges that the firm violated Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) and the related rules. The individual defendants are each alleged to have caused the violations.
To resolve the action each Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order. In addition, Messrs. Pearson and Wirth each agreed to pay a penalty of $50,000 while Mr. Corless will pay a $25,000 civil penalty.