PE principals settle valuation/conflicts cases

The Foundry Capital Group case checks all the boxes for the SEC's 2021 exam priorities.

The principals of an Indiana private fund advisor have agreed to settle SEC accusations that they played fast and loose with the fund’s valuations and failed to disclose conflicts of interest – an enforcement case that may be a harbinger for the year to come.

Foundry Capital Group co-founder and former co-owner Troy Marchand will be banned for at least five years; his former partner and former firm CCO, Tyler Sadek, is censured and will pay $30,000 in fines; and current Foundry owner Scott Wolfrum is censured and will pay more than $236,000 in fines, disgorgement and prejudgment interest, the Commission announced in separate orders released March 24.

Regulators say that Marchand, 35, and Sadek, 39, started Foundry in 2015 and launched its Foundry Mezzanine Opportunity Fund later that year. The fund was supposed to execute “high-yield private loan investments with complementary short-term liquidity plays” and its primary source of income was interest on loans to portfolio companies. Its limited partnership agreement gave Foundry Capital discretion on valuations but required the advisor to use “fair and reasonable” methods to calculate them. The fund’s private placement memos promised that its net asset value would be “based on independent appraisals.”

“To the contrary,” regulators say, “Marchand determined to keep the value of the holdings at cost.”

When the SEC laid out its 2021 exam priorities, regulators promised that they would examine private fund advisers for rigorous compliance programs, thorough disclosures, liquidity problems (including valuations) and even debt structure. The Foundry case checks all those boxes and suggests that similar enforcement actions may be coming soon.

Valuation promises

Throughout 2016 and into early 2017, regulators say, Marchand and Sadek kept promising to have a third firm – identified in court papers only as “Valuation Firm A” – conduct Foundry’s valuations. Firm A didn’t get around to it until early 2017. By then, Firm A staff told Marchand that Foundry would probably have to write down some of the fund’s value, the Commission says.

According to regulators, Marchand told Firm A staff that it was impossible to value one holding because it didn’t have any revenue. “We were going to have to take a mark down on everything according to their methods,” Marchand’s settlement order quotes him as saying.

“Marchand chose not to continue the engagement with Valuation Firm A or use its preliminary valuations, or otherwise get independent appraisals as represented in the PPM and other investor communications, and instead decided to maintain the values of the holdings at cost,” the Commission says. “Marchand also ignored valuation criteria suggested by the fund’s auditor and repeatedly failed to give weight or consider the impact on valuations of certain negative financial and operational information he learned about some of the Fund’s holdings, such as operational problems, the inability to pay expenses, and their failure to pay interest.”

Marchand also was sloppy in his due diligence, regulators say. Three different holding companies had trouble paying back loans, the SEC claims, but Marchand kept shoveling money in, all the while misleading investors through the quarterly newsletters he and Sadek wrote, edited and sent out.

Conflicts of interest

Wolfrum was an early believer in the mezzanine fund, regulators say. From 2015 until he bought Marchand and Sadek out in 2018, Wolfrum sold more than $20 million of the fund to his clients through his unregistered advisory firm, Wolfrum Capital Management, and to his clients at David A Noyes & Co, where he worked as a broker-dealer, his settlement order states.

But he “failed to disclose to his clients the conflicts of interest created by his and his family members’ financial interests in two of the fund’s holdings and Wolfrum’s receipt of $140,125 in finder’s fees for facilitating two different investments by the fund,” regulators say.

Wolfrum, at least, got ahead of his problems. In its settlement order, the SEC hails him for his “remedial acts.” As part of his settlement, Wolfrum will have to send a copy of his settlement order to his clients within 30 days and to certify in writing that he’s done so, within 60 days.

Last year, Foundry filed its first and so far only Form ADV. It lists Wolfrum as the firm’s sole managing member and CCO. But Foundry’s Part 2 brochure says that “Wolfrum is in the process of finalizing partnering agreements with three industry-experienced professionals to assist with the ownership and management of Foundry and its Mezzanine Opportunity Fund.”

Wolfrum, Marchand and Sadek did not respond to requests for comment.

This article first appeared in affiliate publication Regulatory Compliance Watch