By Matt Jarzemsky and Aruna Viswanatha
Flashy financier Lynn Tilton and her Patriarch Partners LLC are
facing allegations that they defrauded investors by hiding the true
value of loans in some funds managed by the private-equity
firm.
The Securities and Exchange Commission on Monday said Ms. Tilton
and Patriarch, which invests in troubled companies, "breached their
fiduciary duties" by valuing the loans using a different
methodology than described in the funds' offering documents. In
doing so, Ms. Tilton misled investors about the quality of complex
investment products managed by Patriarch and collected almost $200
million in fees she wouldn't otherwise be entitled to, the agency
said.
Ms. Tilton created "a major conflict of interest that was never
disclosed" to investors, SEC enforcement director Andrew Ceresney
said in announcing the case. The SEC filed the charges before an
internal administrative law judge but didn't disclose what
penalties it is seeking.
Ms. Tilton said Patriarch has adequately reported the funds'
performance to investors who are well aware of how her firm
operates. Patriarch manages companies that are largely owned by the
loan funds, known as collateralized loan obligations.
None of the investors in Patriarch's CLOs--large, sophisticated
institutions--has ever complained to the firm about its practices,
she said.
"I'm choosing to fight," Ms. Tilton said. "My reputation is very
important to me and my companies. When my integrity or my intent
are questioned, I fight back and let truth prevail."
The dust-up pits Ms. Tilton, who launched Patriarch with her own
money 15 years ago, against a regulator pushing for greater
transparency from investment firms. Patriarch has invested in more
than 75 companies, including auto-parts supplier Dura Automotive
Systems and mapmaker Rand McNally, according to its website.
Ms. Tilton, a rare woman at the helm of a private-equity firm,
is known for her frank manner and brash personal style.
After a Ford Motor Co. executive asked her whether she would
"strip and flip" her companies, she responded, "it's only men that
I strip and flip. My companies I hold long and close to my heart,"
according to a 2011 profile in The Wall Street Journal.
Several years ago, she was slated to star in a reality
television show focused on her business dubbed "Diva of
Distressed," but the show never aired.
Ms. Tilton, who said she spends about 300 days a year traveling
to Patriarch's companies, sports the résumé of a Wall Street
veteran. She has worked at Morgan Stanley, Goldman Sachs Group Inc.
and Amroc Investments LLC, the investment firm co-founded by
billionaire investor Marc Lasry.
At issue is how Patriarch reported the value of investments held
by three CLOs--pools of corporate loans made or purchased with
investor funds. The funds, known as the Zohars, are managed by
Patriarch and have raised more than $2.5 billion from investors,
according to the SEC.
The SEC said Patriarch failed to appropriately communicate to
investors that some loans in the pools were actually in
default.
"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 said.
Ms. Tilton said the CLO fund documents don't require Patriarch
to classify loans with short-term problems in default, she said.
Indeed, she added, bumps in the road are normal for many of her
companies because she actively seeks to invest in distressed
businesses.
The conflict stems in part from Patriarch's strategy of managing
the companies in which its CLOs invest.
"It is not passive by any means, but a very active strategy
where the value depends deeply on our participation," Ms. Tilton
said.
Some of Patriarch's companies have ended up in bankruptcy. In
February, the firm asked investors to discuss a restructuring of
the three Zohar funds, according to an investor letter reviewed by
The Wall Street Journal. The reorganization could include delaying
repayment or reducing the amount of principal investors would
receive, the letter said.
Mr. Ceresney said the SEC brought the case through its in-house
court in part to try to move it quickly, since one of the funds at
issue has a maturity date of November 2015. The agency has stepped
up its use of the courts in recent years, to some criticism from
defendants who argue the process is titled toward the commission
and doesn't offer the same protections as U.S. federal court.
A spokesman for Patriarch said Ms. Tilton, through her personal
affiliates, owns more than two thirds of the notes and the equity
in the fund with the November maturity. "This case belongs in
district court," he said.
The Wall Street Journal reported in October the agency had a
100% win rate for the 12 months through September when it brought
cases before SEC-appointed administrative judges. Earlier this
month, the agency lost part of a case it brought in the forum.
Write to Matt Jarzemsky at matthew.jarzemsky@wsj.com
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