Lynn Tilton at the Living Legends of Aviation Awards in January. (Photo: AP)

The Securities and Exchange Commission said Monday that it has charged Lynn Tilton, head of Patriarch Partners, as well as Patriarch’s affiliated firms with defrauding clients out of hundreds of millions of dollars by hiding the poor performance of loan assets in three collateralized loan obligation funds.

The SEC’s Enforcement Division alleges that Tilton and her New York-based Patriarch Partners firms breached their fiduciary duties and defrauded clients by failing to value assets using the methodology described to investors in offering documents for the CLO funds, which have portfolios composed of loans to distressed companies. 

The three CLO funds managed by Tilton and the Patriarch Partners firms are collectively known as the Zohar funds, and more than $2.5 billion has been raised from investors. The $2.5 billion is “the amount at issue,” SEC Enforcement Director Andrew Ceresney said on a Monday call with reporters.

Nearly all valuations of loan assets have been reported to investors as “unchanged from the time they were acquired despite many of the companies making partial or no interest payments to the funds for several years,” the SEC states.

The SEC alleges that instead of informing their clients about the declining value of assets in the CLO funds, “Tilton and her firms have consistently misled investors and collected almost $200 million in fees and other payments to which they were not entitled,” said Ceresney. “Tilton violated her fiduciary duty to her clients when she exercised subjective discretion over valuation levels, creating a major conflict of interest that was never disclosed to them.”

The SEC alleges that Tilton and her firms’ behavior fall under the anti-fraud violations of the Investment Advisers Act. Ceresney stated on the call that while the SEC hasn’t yet “articulated” an exact penalty amount, the SEC has “asked for certain remedies” that will be based on “tiers of the violation.”

This isn’t the first time that Tilton’s CLO funds have come under scrutiny. Tilton and her firms have been sued for claims ranging from breach of contract to fraud.

The securities regulator alleges that investors have not only been misled to believe that objective valuation analyses were being performed, but that Tilton and her firms “allegedly have avoided significantly reduced management fees because the valuation methodology described in fund documents would have given investors greater fund management control and earlier principal repayments if collateral loans weren’t performing to a particular standard.”

Tilton and her firms also consequently have misled investors about asset valuations in fund financial statements, the SEC said. Ceresney said on a Monday call with reporters that assessing valuation of fund assets remains a “priority” of the enforcement division.

According to the SEC’s order instituting an administrative proceeding, CLO funds raise capital by issuing secured notes and using proceeds to purchase a portfolio of collateral typically composed of commercial loans. Investors are paid based on cash flows and other proceeds from the collateral. “Tilton’s investment strategy for the Zohar funds has been to improve the operations of the distressed portfolio companies so they can pay off their debt, increase in value and eventually be sold for a profit,” the SEC states.

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