Fifth Street Finance Corp. targeted by securities suit

A securities class action suit has been filed against a specialty finance company and some of its managers following claims that it violated federal securities laws.

The class action lawsuit against Fifth Street Finance Corp. was filed in the U.S. District Court for the Southern District of New York on behalf of individuals who purchased shares in the company during the class period between July 7, 2014 and Feb. 6, 2015, according to a press release. The allegations come following claims that investors in FSC, Fifth Street Asset Management Inc. and Fifth Street Senior Floating Rate Corp. suffered losses after undisclosed information about the company became public. The suit alleges that as a result FSC, FSAM and some of its officers violated the Securities Exchange Act of 1934.

Asset management company allegedly artificially inflated revenue
FSC lends to small- and mid-sized companies through investments by private equity sponsors. The credit-focused asset manager controls over $5 billion worth of assets across two publicly traded entities – FSC and Fifth Street Senior Floating Rate Corp.

“The defendants allegedly developed a ‘fraudulent scheme and course of business'”

The class action filing alleges that the defendants developed a “fraudulent scheme and course of business” meant to artificially inflate the company’s assets and investment income to boost FSAM’s revenue during the class period. The suit claims that the defendants drove FSC to make risky, speculative investments at untenable leverage levels, postponed writing down impaired investments to make it look as though FSAM’s revenue was rising and repeatedly exaggerated the income produced through FSC’s investments and the fair value of its portfolio. At the same time, the lawsuit alleges that the defendants provided investors and the market with false and misleading representations of FSC’s business and performance.

Since FSAM’s revenues are directly linked to FSC’s gross assets and reported income, as the latter’s portfolio grew larger and its income increased FSAM’s own revenue stream appeared to investors to be appreciating. As a result, the defendants were allegedly able to sell FSAM shares to the public at higher prices. On Oct. 29, 2014, the defendants sold 6 million FSAM shares for $17 per share. As a result, they received tens of millions of dollars from the sales of their shares. The gross cash proceeds for the company’s IPO alone were around $100 million.

Fourth quarter fiscal results reveal reality of FSC’s business
On Feb. 9, 2015, FSC reported its fiscal results for the fourth quarter of 2014, the same quarter in which the defendants held the company’s IPO. FSC disclosed that about the same time the company’s executives were taking it public, it moved $106 million worth of investments to non-accrual status with $17 million more to be categorized non-accrual in the following quarter. Together these amounts comprised around 5 percent of the FSC’s whole debt investment portfolio on a cost basis.

FSC'sFSC’s net investment income dropped in the fourth quarter of 2014.

The company also disclosed that though the total assets in FSC’s investment portfolio had grown to close to $3 billion by the end of the quarter, the asset management firm’s net investment income dropped by 6 percent quarter-over-quarter. The unrealized depreciation of the company’s investments for the quarter had grown to $62 million and its quarterly net realized losses were $17.6 million.

Though the asset management firm announced a 10 percent dividend just four months before taking FSAM public, FSC stated that it would issue zero dividends for February 2015. Additionally, the company decreased future dividend payments by 30 percent through a more “conservative” dividend program. Following the revelations, the price of common stock in FSC fell close to 15 percent on volume of almost 11 million shares.

For more information on this case or other class action litigations, please contact Adam Foulke at 203-987-4949 or info@battea.com.