SEC Settles with Portfolio Manager of Private Equity Fund of Funds Over Undisclosed Valuation Practice That Inflated Fund Performance in Marketing Materials and Investor Reports

by Goodwin

The SEC settled public administrative proceedings against a portfolio manager (the “Portfolio Manager”) over misrepresentations he made or caused to be made to prospective and existing investors in the private equity fund of funds he managed (the “Fund”) regarding the manner in which the Fund’s largest asset (the “Underlying Fund”) was valued.  The SEC found that Fund marketing materials, primarily the Fund’s pitch book, and reports to existing Fund investors misrepresented the manner in which the Fund’s investment in the Underlying Fund was valued and that the Portfolio Manager’s undisclosed implementation of an alternative valuation methodology materially increased Fund performance over what it would have been had the valuation methodology disclosed in marketing materials and quarterly reports been applied.  The SEC also found the Portfolio Manager at fault for providing or directing others to provide marketing materials that presented Fund performance that did not reflect the effect of Fund-level expenses.

This article provides selected highlights of the SEC’s findings set forth in the settlement order (which the Portfolio Manager has neither admitted nor denied).  In 2013, the SEC settled public administrative proceedings against the registered investment adviser and its wholly owned subsidiary, also a registered investment adviser, (together, the “Adviser”), that employed the Portfolio Manager, relating to the same general underlying findings (as discussed in the March 19, 2013 Financial Services Alert).

Use of “Gross” Fund Performance

From September 2009 through at least mid-October 2009, the Portfolio Manager sent or directed others to send to consultants and prospective Fund investors pitch books reporting an internal rate of return (“IRR”) for the Fund for the quarter ended June 30, 2009 that did not deduct fees and expenses paid to underlying fund managers and the Adviser (“gross IRR”).  Including expenses at the Fund and Underlying Fund levels would have lowered the Fund’s IRR from the 12.4% reported in the pitch books to -6.3%.  The SEC found that the Portfolio manager had primary responsibility for the content of the pitch books.   

Improved Fund Performance Based on Undisclosed Change in Valuation Methodology

On October 15, 2009 Portfolio Manager submitted marketing materials with the June 30, 2009 gross IRR to the Adviser’s compliance staff (“Compliance”).  In response to comments from Compliance referencing the impact of expenses on the Fund’s return, the Portfolio Manager revised the pitch book to present the Fund’s IRR after the effect of the expenses of underlying funds, but without taking into account Fund-level expenses.  At the same time, the Portfolio Manager increased the valuation of the Underlying Fund from $6 million to approximately $9 million, basing this new valuation on the “par” value of the sole asset held by the Underlying Fund rather than, as disclosed in the pitch book and October 7, 2009 quarterly report, the value of the Underlying Fund as reported by the Underlying Fund’s manager. The Fund had up to this point reported the value of its investment in the Underlying Fund at cost, which was the fair value provided by the Underlying Fund’s manager.  Without updating disclosures regarding the valuation method used by the Fund, the Portfolio Manager revised the IRR shown in the pitch book to reflect the higher valuation for the Underlying Fund based on par value, resulting in an increase in reported IRR from 12.4% to 38%.  The reported IRR reflected the effect of expenses at the underlying fund level, but not at the Fund level.  The revised pitch book was not submitted to Compliance.  The Fund IRR based on par value for the Underlying Investment was also used in quarterly reports sent to Fund investors for the third quarter of 2009 and the year ended December 31, 2009.  

The SEC found that on numerous occasions during the period from October 26, 2009 through June 30, 2010, the Portfolio Manager also made and caused others to make the following misrepresentations in connection with marketing the Fund to existing and prospective investors and to consultants: (i) the increase in the value of the Underlying Fund was due to an increase in performance (when, in fact, the increase was attributable to Portfolio Manager’s use of par value for the Underlying Fund investment); (ii) the increase in the Fund’s IRR was attributable to increased valuations provided by third party evaluation firms (when no such valuations were provided); and (iii) the Fund’s underlying funds were audited by independent, third party auditors (when, in fact, the Underlying Fund was not audited).  

The SEC found that marketing efforts for the Fund during the period from October 2009 to June 2010 resulted in approximately $61 million in investments from new and existing investors.

Violations of Law

The SEC found that the Portfolio Manager willfully violated the anti-fraud provisions of Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, relating to the purchase or sale of securities.  The SEC also found that the Portfolio Manager willfully violated Section 206(4) of the Advisers Act and Rule 206(4)-8 thereunder, which generally prohibit material misstatements or omissions to, and fraudulent, deceptive or manipulative practices by an investment adviser with respect to, any investor or prospective investor in a pooled investment vehicle.


In addition to a cease-and-desist order, the SEC imposed a civil money penalty of $100,000 on the Portfolio Manager and imposed an industry bar on the Portfolio Manager relating to (a) association with any broker, dealer, investment adviser, municipal securities dealer, municipal advisor, transfer agent, or nationally recognized statistical rating organization and (b) service in various capacities with respect to a registered investment company, subject in each case to a right to apply for reentry after two years to the appropriate self-regulatory organization, or if there is none, to the SEC.

In the Matter of Brian Williamson, SEC Release No. 33-9515 (January 22, 2014).

IRS Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this informational piece (including any attachments) is not intended or written to be used, and may not be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

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