United States: SEC Charges Investment Adviser for Inadequate Policies and Procedures Regarding Valuation of Private Fund Assets

By Todd Gibson, Annabelle North, and Aster Cheng

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.