An SEC investigation found that Colorado-based investment adviser Deer Park Road , in connection with one of its funds, failed to have policies and procedures to address the risk that its traders were undervaluing securities and selling for a profit when needed. The SEC fined a hedge fund $5 Million, and its Chief Investment Officer another $250,000, for failing to properly value portfolio securities.
In the order, the SEC maintains that the firm failed to sufficiently address how to conform the firm’s valuations with GAAP. In addition, they were not designed for its own business practices, given the firm’s models and potential conflicts.
Even worse, Deer Park Road didn’t follow its existing, yet deficient, policy. The policy was important because the fund focused on thin-traded mortgage-backed securities.
Another aspect of its deficiency was the membership of the firm committee that was responsible for making sure valuations were in compliance with the firm’s pricing source protocol. The members were:
- CCO – a former geochemist with no relevant experience in bond valuation
- CFO – former bookkeeper and tax accountant with no experience in bond valuation
- Untitled person – an attorney with no experience in bond valuation.
Of course there are messages noting the failure to mark assets to the market price.
“we are fundamental oriented, and price them based on future cash flow . . . . Mkt seems to be willing to buy at lower yield, which is only a technical issue, but we may sell our bonds at mkt price, only to take realized profits then rather than mark them up to book unrealized profits.”
“don’t you know me at all / I don’t mark stuff up / stay as conservative as possible.”
“[w]e mark it low. it can trade much higher . . .” and “undervalued, can trade low60s…. can sell it for profit if needed.”
Wait a second…. This is a different type of valuation case. Based on the order, the manager was staying conservative with fund valuations. The assets were not over-valued; they were UNDER-VALUED.
The SEC order does not allege any harm to investors. The SEC does not accuse the firm of making extra money by keeping the values low. The SEC accuses the firm of allowing its traders to “mark assets up gradually instead of marking them to market.”
Of course, valuation is important. You can’t ignore obvious market indicators on value.
I have to assume there are other matters that didn’t make it into the Order that caused the SEC to pursue this case and seek a $5 million fine.