Story Series: Direct Lending Investments
Update: DLI has agreed to the appointment of a receiver to marshal and preserve the assets of Direct Lending and the funds. The SEC has also published a press release on the matter.
One of the biggest online lending hedge funds has been accused of fraud by the SEC. On Friday, the SEC sued Direct Lending Investments (DLI) with perpetrating a multi-year fraud that misrepresented the value of loans in a segment of its portfolio.
A DLI employee told the SEC that CEO Brendan Ross helped engineer loans to be valued at par when they should’ve been valued at zero. Emails between Ross and the online loan platform suggest that this was intentional, the SEC argued. The effect of this was that between 2014 and 2017, DLI overstated the valuation of one of its loan portfolio positions by approximately $53 million and misrepresented the fund’s performance by about 2-3% annually.
The SEC seeks a preliminary injunction and appointment of a permanent receiver; permanent injunctions; disgorgement with prejudgment interest, and civil penalties.
Below: DLI’s stated monthly returns 2013-2016
A 2017 DLI investor presentation touted “double-digit returns with no down months since inception” and a portfolio that has “exhibited little volatility.”
Direct Lending Fund CEO Brendan Ross, has resigned, according to Bloomberg News and numerous individuals identifying themselves as investors on an industry blog. The fund not only lost nearly 25% of its portfolio in a single sour investment, but it’s reported that they may have overvalued its investments in QuarterSpot’s small business loan platform.
The fund was reputed as one of the largest funds in the online lending industry and one that “historically earned investors unlevered double digit returns” by investing in online loan marketplaces.
Were there signs of problems?
In a tell-all book published by DealStruck founder Ethan Senturia in late 2017, Senturia describes how Ross’s fund had been overly dependent on his company’s success. “I am like, literally staring over the edge. My life is over,” Senturia quotes Ross as saying in Unwound when he became aware of DealStruck’s downward spiral*. Despite this characterization, Ross’s fund continued to grow relatively unscathed.
Meanwhile, James R. (“Jim”) Hedges, IV wrote an op-ed in Mid-2017 on Lend Academy of a mystery fund he refused to identify that had a Bernie Madoff-feel to it. In the comments, users point out that the monthly returns matched the ones on Direct Lending’s investor letters.
“When I first saw these returns, I instinctively thought of Madoff,” Hedges wrote. “The narrow band of returns is, in my experience, highly unusual and inconsistent with the returns of investments being marked-to-market. To be clear, I am not saying that this fund is a fraud. I am stating that the performance they’ve reported is, in my experience, unlikely indicative of a valuation methodology that accurately reflects the month-to-month performance of the underlying assets.”
*DealStruck announced a restructuring in December 2018