Patriarch Partners’ Tilton Battles SEC as Fraud Trial Begins

  • Agency claims investors in $2.5 billion pools were misled
  • Tilton’s lawyers accuse SEC of ‘unholy alliance’ with MBIA

Patriarch Partners founder Lynn Tilton is a character but she’s no fraud, her lawyer told an SEC judge at the start of a trial over claims that the firm misled investors about the value of assets backing three debt funds worth $2.5 billion.

The U.S. Securities and Exchange Commission’s fraud case, which Tilton has been trying to dodge for more than a year, seeks to force her to give up $200 million in fees collected on the debt funds plus additional penalties. She’s denied wrongdoing, and her lawyers claim she’s been wrongly targeted by the agency. If she loses, the 57-year-old financier could be barred from the securities industry.

“She’s a character, she’s larger than life and she’s all woman,” lawyer Randy Mastro said Monday during a hearing in Manhattan.

The trial is taking place as part of the SEC’s in-house enforcement process before Administrative Law Judge Carol Fox Foelak. SEC lawyer Dugan Bliss began laying out the case against Tilton by telling the judge she “hid the truth” about how she manipulated the underlying categorization of the funds’ assets.

Business Empire

Tilton founded Patriarch in 2000 after working at Goldman Sachs Group Inc. and other big Wall Street investment banks. She built a business empire selling structured finance bonds before the market for such debt blew up in the 2008 financial crisis. In March 2015, a five-year SEC investigation culminated in an administrative lawsuit accusing the private-equity firm of fraud. 

Tilton went on the offensive, filing lawsuits to force the case into federal court and away from an in-house SEC hearing officer. She argued the agency’s enforcement process was unfair and violated the U.S. Constitution. Last month, the U.S. Supreme Court rejected her request to stop the case pending a review of her constitutional challenge. And last week, she dropped a lawsuit seeking to delay the SEC hearing.

“I’ve never fit the mold of Wall Street and the private equity industry, and it appears that this has made me a target,” Tilton said in an e-mailed statement before the start of the trial. “But I believe that ultimately the truth will prevail.”

Patriarch invests in distressed companies such as Dura Automotive Systems Inc., Spiegel Catalog Inc., MD Helicopters Inc. and Rand McNally & Co., in hopes of restructuring and improving their value. Tilton pioneered a form of financial engineering allowing her to bundle loans to distressed companies, turn the debts into securities and then sell them to investors. 

Loan Pools

She managed the companies to improve their finances and pay the loans, the proceeds of which were then used to pay investors. The SEC case focuses on three such loan pools: Zohar I, Zohar II and Zohar III, launched in 2003, 2005 and 2007, respectively. 

The SEC argues Tilton defrauded investors by failing to disclose poorly performing loans. The agency claims that allowed her to collect $200 million in fees since 2009 that should have gone to investors.

Investors knew Tilton was using her expertise with broken companies to make them money, Mastro said. She was given the discretion to let them defer payments when necessary and delays and postponed payments were disclosed in reports to investors, he said. He ridiculed the idea that the SEC was “shocked, shocked” to learn that troubled companies were missing payments on their loans.

Complicated Cases

Others who have challenged the SEC say the agency’s in-house proceedings don’t give defendants the same protections they would enjoy in federal court and that they’re unfair, particularly in complicated cases like Tilton’s. She will have to wait until after the administrative proceeding to litigate the constitutional issues she raised against the process, Mastro said in an e-mail earlier on Monday.

Tilton, who’s called the SEC’s claims “utterly meritless,” accuses the agency of improperly sharing information with MBIA Inc., which insured the senior notes in Zohar I and II, for a total exposure of about $1 billion. Mastro told Foelak in a telephone hearing last week that the agency and MBIA worked together in an “unholy alliance where rules were broken and confidential information was shared” to use against Tilton.

The SEC has said it did nothing wrong. Communication with MBIA was permitted as part of the investigation, the agency said.

The case is In the Matter of Lynn Tilton, 3-16462, U.S. Securities and Exchange Commission (Manhattan).

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