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Failure to Disclose Loans Among Affiliated Funds

Posted on March 26, 2015 by Doug Cornelius
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Southern Loans neon sign - Kingsport, TN

Once you hear the words “inter-fund loans”, a compliance professional is going to sit up straight and be concerned. Anything “inter-fund” is an inherent conflict. That one fund is loaning another fund money is an indicator that something has gone wrong.

Stilwell Value managed several private funds. According to the SEC order, the Stilwell funds made at least eight loans to other funds. The loans were relatively short – days to six months. At the time they were made, the loans were not documented and the terms were not memorialized.

The big problem is that the loan terms were not necessarily at market prices, so one fund was profiting from the other fund. If the rate was below market, the borrower was gaining at the expense of the lending fund. The firm should have documented the process to confirm the loans were at market rates. Of course that is assuming the fund documents permit the affiliate loan and, if so, that the conflict is disclosed.

According to the SEC order, Stilwell was taking a big position in a public company. Stilwell is known as an activist investor. It was trying to take the position to influence the company. Some funds needed liquidity, but only had the public company stock. Rather then sell some stock for liquidity, Stilwell made the inter-fund loans.

One thing to note is that the settlement order includes no findings that fund investors were harmed. Stilwell agreed to disgorge to investors of the lending funds more than $239,000 representing management fees charged to the lending funds with respect to the loans, plus pre-judgment interest.

If the name Stilwell sounds familiar, it’s because he was fighting back against the SEC for bringing the action in an administrative court instead of federal district court. In a related development, Stilwell dismissed its suit against the SEC claiming that the SEC administrative proceeding before an administrative law judge was unconstitutional.

Sources:

  • Goodwin Procter’s Financial Services Weekly News Roundup
  • In the Matter of Joseph Stilwell and Stilwell Value (.pdf)
  • SEC Looking Into Loans Made Between Stilwell Funds in the Wall Street Journal
  • Activist investor Stilwell sues SEC to stop enforcement case by Jonathan Stempel
  • Activist investor Stilwell settles SEC case he claimed was illegal by Nate Raymond and Jonathan Stempel

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