Back in 2012, the Securities and Exchange Commission filed suit against Yorkville Advisors for valuation failures. According to the SEC complaint, the failure was two-pronged: one of misstatements and a second failure to follow the funds’ own policies and procedures on valuation. Yorkville denied the charges.
Legal action has continued and Yorkville has been largely vindicated in a motion for summary judgement.
The SEC lost virtually all claims in the asset valuation case brought against a fund and two of its officials.
As with most private fund managers, Yorkville’s ability to understand the valuation of its investments is critical to its strategy and results. So you would expect some discretion to be granted to the manager, without the SEC second-guessing the valuation. The SEC second-guessed the values and lost.
The key should be precision ahead of accuracy. Precision is getting close to the same result consistently. Accurate is getting close to the right target. You can be precise and inaccurate, and you can be accurate but imprecise. With a hard to value asset, where its hard to know the correct target, precision is more important.
The SEC case was focused on 15 privately negotiated, customized securities in its portfolio that had little to no market activity.
Yorkville was using GAAP in calculating the net worth of each fund and marking the funds’ investments to fair value. It used one valuation adviser to help value some of those 15 positions. Yorkville ended up rejecting most of the first attempts because it thought the valuations were too high. Yorkville hired a second valuation company to help with some of the investments it had to foreclose on. Yorkville’s audit form signed off on the valuations. The auditor re-examined the work after the SEC was filed, discovered that it did not have some the draft valuation work, but concluded that it could still stand behind the audits.
Prior to 2008, the firm marked positions at the lower of cost or market value until gains were realized. The firm would recognize unrealized losses but not unrealized gains. Yorkville adopted FASB Statement 157 in 2008 which changes to the treatment to always be fair market value accounting.
The SEC claimed that Yorkville overvalued the 15 investments by at least $50 million as of December 2008 and $47 million as of the end of December 2009. The over valuations inflated the value of the funds which attracted investors and increased the fees that Yorkville charged.
The opinion starts with precluding a big chunk of the testimony of the SEC valuation expert. The court found that the Uniform Standards of Professional Appraisal Practice call for a review to be one of the quality of the of the valuation process and not to create a new value based on the review.
Then the court moves on to deciding if there was evidence to support a finding of scienter or intent to deceive. The SEC used three theories as to why the Yorkville principals had the motive and opportunity to commit fraud.
First, the court rejected the claim that motive and opportunity could be established from the Yorkville’s compensation structure. The court refers to established law that the mere desire to earn management fees is not sufficient to allege a concrete and personal benefit resulting from the fraud.
Second, although Yorkville was in a tough financial position (it was 2009-2009) and would be better off it could raise more funds from investors, it was not enough to prove an intent. The SEC was claiming that Yorkville kept the valuations high to attract more investors. That did not meet the test.
Thirdly, the principals redemption of interests in the fund did not have the facts to show fraud. Yorkville was actively marking the Fund down by $33 million at the time of the redemption request. .
The Court also rejected the SEC’s claim that the Yorkville principals had fraudulent intent because they failed to disclose key documents to the outside auditors and made affirmative misrepresentations regarding the 15 positions to the investors and auditors. The court rejected that, noting that the auditors still stood behind their audits. Although, the audit partner claims that a dozen documents, out of hundreds of others, were not provided to the auditors.
It looks like Yorkville was a bit sloppy in its statements regarding its use of outside consultants to help in valuations. Some of these sloppy statements were in investors’ DDQs. Some of those charges survived the summary judgment order and ill have to be contended. So, Yorkville did not come out of this case completely vindicated.
The Yorkville case was one of several brought as part of the Commission’s Aberrational Performance Inquiry which was tied to about a half dozen cases.The Inquiry is supposed to use performance metrics to identify outlying performance and use that to suggest suspicious conduct.
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