August 20, 2019

Recent SEC OCIE examination findings and enforcement actions have sparked a trend of increased scrutiny on fund valuation. Especially with the emergence of digital assets/cryptocurrencies as a new asset class, valuation continues to be an ever-increasing focus area of regulators. Stout recently hosted its’ annual investment fund evaluation event in New York that brought together members of the local investment community and industry experts to discuss these key issues.

The event, moderated by Stout Managing Director Jesse Morton, featured the following panelists:

  • Amit Joshi, Chief Accounting Officer, Apollo Investment Corp.
  • Thomas Friedmann, Partner, Dechert LLP
  • Will Coleman, Director, Technology Advisory Services, Cohen & Co.
  • Jamie Spaman, Managing Director, Stout
  • Matt Rogers, Director and National Leader of SEC and Accounting Advisory Practice, Stout

In this segment, Thomas Friedman, Matt Rogers, and Jaime Spaman share their perspectives on the SEC and Morgan Keegan settlement and the lessons learned. Listen to the recording or read the transcription below to get their perspective:

Jesse Morton: 

One of the, probably, most important cases in valuation  is the Morgan Keegan case and if you could talk about that a little bit ...

Thomas Friedman:

Sure.

Jesse Morton:

And some of the lessons learned.

Thomas Friedman:

Sure. What is interesting about Morgan Keegan is, as I mentioned earlier, it's important when you're thinking about your valuation process that you involve the board as much as possible. They're an objective person and part of it, they're empowered by law to oversee the fund.

But, quite frankly, it is it's kind of inoculating the advisor who has an interest in the outcome of the valuation so you have some evidence of oversight that can be helpful if there's a problem later. I think one of the corollaries to that is until Morgan Keegan, I won't say it's never happened, but the SEC is always a little bit wary of challenging independent directors. They view the independent directors within the fund as their allies, they've given speeches to this effect, they don't want to discourage prominent people from sitting on boards and exercising oversight and so they are reluctant to bring enforcement actions. 

I think with Morgan Keegan, the fact patterns were fairly horrendous in the sense that there was evidence that the board of directors was not familiar, quite frankly, with the valuation policies and procedures that had been established by the advisor. There was evidence that there was no periodic review of the valuation policies and procedures that have been implemented nor was there any follow-up when there were apparent deviations between valuations that were coming out of the valuation process and the policies and procedures that had, in theory, been established by the board. 

When you put all of those things together, I think the SEC felt that it couldn't simply bring an action against the advisor because whether or not there was complicity or not, I don't think they'd challenge, but they focused almost entirely on process and they demonstrated it to the satisfaction of the court that the board had not exercised appropriate oversight in that case.

I think that was helpful, that was a shot across the bow to boards to stay engaged, but I think then quickly the staff actually gave some speeches saying, "If the board is following their policies and procedures that they established and conducting appropriate oversight that that should not be taken as a challenge to the role of independent directors that independent directors need to do what they're charged with doing, but people shouldn't resign from boards en masse because it becomes a liability from being a director." I don't know, Matt, you obviously were involved in this a little bit. Were you at the event?

Matt Rogers:

I think what you're saying is accurate about the board of directors. They are reluctant to bring actions against them because they have because they want them to sit, they want prominent people to sit on boards. But obviously, any time things are so far astray from the  norm, the Enforcement Division is going to take some action and make a statement. In this case, it does.

Jamie Spaman:

Yeah, I would add a couple of things. We had a lot of discussions with boards after that about real concerns by independent directors who often have an enormously high net worth, they're getting, what, 80, $100,000 a year to sit on this board and they say to themselves, "That's not a very good arrangement. I'm putting my entire net worth at risk, potentially, if I was found personally liable. On the other hand, I'm getting a relatively small compensation for doing so." 

We did spend time with them, but frankly, as I said, the SEC was outspoken in saying that, "This is not a routine, this is not our normal posture, but this was an extreme case." I think that it's settled down a little bit, but that was an effective shot across the bow and all of our boards that we work with, I think really snapped to attention and spent more time on kicking the tires on valuation policies. People talked about some of that, but that had the desired effect.

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