The U.S. Securities and Exchange Commission (SEC) filed charges alleging that entrepreneur Lynn Tilton and her investment firm Patriarch Partners defrauded investors by failing to properly value loan assets within funds they managed. Patriarch Partners strongly refuted the charges, saying that it will "vigorously defend" itself against the proposed SEC enforcement action. The group owns MD Helicopters, which has made news recently by supplying armed helicopters to the Afghan Air Force.
Announcing the charges on March 30, the SEC said Tilton and the Patriarch entities she owns failed to value assets in three collateralized loan obligation (CLO) funds they managed using the methodology described in offering documents to investors. A CLO fund raises money by issuing secured notes and using the proceeds to purchase a portfolio of collateral, typically composed of commercial loans. Clients invest in the funds in return for regular interest payments and the repayment of their principal on a specified maturity date.
The CLO funds Tilton and her firms managed, called Zohar I, II and III, starting in 2003 raised $2.5 billion from investors. Tilton’s investment strategy for the funds was to improve the operations of distressed companies within the portfolios, pay off their debts, increase their value and eventually sell them for a profit. The SEC alleges that Tilton and the Patriarch entities hid the “poor performance” of loan assets within the funds. “Instead, 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 agency said in a press release announcing the charges.
The SEC also alleges that by not using the valuation methodology described in offering documents, Tilton and her firms collected nearly $200 million in management fees to which they were not entitled, because the valuation methodology would have given investors greater fund management control if the loans serving as collateral weren’t performing to a particular standard. “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,” stated Andrew Ceresney, director of the SEC’s enforcement division.
The SEC’s 13-page order, which initiates administrative proceedings, does not name specific companies within the Zohar portfolios. The issuance of the $1 billion Zohar II fund in 2005 coincides with Patriarch Partners’ acquisition of MD Helicopter Holdings in July that year. Patriarch recapitalized MD Helicopters, based in Mesa, Ariz., as an independent company. It is in the process of delivering 12 new MD 530F armed scout helicopters to the Afghan Air Force under contracts the U.S. Army Contracting Command awarded.
According to the order, the SEC will convene a public hearing before an administrative law judge within 60 days. The charges, if proven, could result in “remedial action,” including civil penalties, the agency said.
Patriarch Partners issued the following statement: “We are disappointed that the SEC has chosen to bring an enforcement action that is ill founded and at odds with Patriarch’s investment strategy, which was consistently disclosed since the inception of the Funds. We look forward to the opportunity to vigorously defend ourselves against the SEC’s allegations. Patriarch is focused on the restructure and rebuild of deeply distressed American companies and we do this through a unique CLO structure that explicitly provides for the flexibility to turn around distressed companies and create value for the Funds and [their] noteholders. The Zohar noteholders are sophisticated investors that have extensive information to evaluate the cash flow performance of the Funds and the performance of the underlying companies. Since its founding in 2000, Patriarch has successfully restructured numerous businesses and has saved hundreds of thousands of jobs.”