United States: SEC Charges Investment Adviser For Inadequate Policies And Procedures Regarding Valuation Of Private Fund Assets – Fund Finance

On 24 May 2023, the US Securities and Exchange Commission (SEC)
announced the settlement of charges against Sciens Investment
Management, LLC and Sciens Diversified Managers, LLC (collectively,
Sciens) related to the valuation of certain private fund portfolio
investments (Order). The SEC cited the often-used violations
of Section 206(4) of the Investment Advisers Act of 1940 and Rule
206(4)-7, finding that Sciens failed to implement adequate policies
and procedures to properly value certain private fund
investments.

Sciens manages a number of private funds that invest in
difficult-to-value assets for which there is frequently no readily
available market pricing information and for which no significant
observable inputs are available (Level 3 Investments). The Sciens
investments, common among many private credit and other private
funds, included private notes and bank loans; equities;
investment-grade and distressed securities in public and private
entities; high yield debt; bank debt; capital structure arbitrage;
special situations and classical distressed investing; rescue
finance; direct lending and investing; specialty finance and other
special co-investment opportunities. The private fund offering
documents provided that Sciens charges percentage fees quarterly
based on the NAV of the applicable share class and values the
assets in a manner believed to reflect the current “fair
market value,” as defined in GAAP.

However, the written policies and procedures did not specify
parameters or provide guidance as to how Sciens would value Level 3
Investments. The only substantive guidance provided in the fund
offering materials indicated that the fair value is to be based on
“available information” and “several non-exclusive
factors” consistent with GAAP’s ASC 820 definition of fair
value. The SEC noted that Sciens’ Compliance Manual lacked
specific valuation techniques or methodologies applicable
to Level 3 Investments to promote consistency in the valuation
process, and procedures designed to address potential conflicts of
interest of Sciens valuing investments they acquired and managed,
since those valuations are used to calculate the management
fee.

Managers to private funds should carefully review their current
policies and procedures as well as disclosure in fund offering
materials related to valuation of Level 3 Investments in light of
this SEC action.

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