Risks and Oversight Failures in Private Credit and Illiquid Assets

The private credit and illiquid asset markets have expanded rapidly in recent years, with the former . While these markets offer attractive returns for investors, they also harbor systemic risks that demand rigorous institutional governance and due diligence. As Jamie Dimon, CEO of J.P. Morgan, has warned, private credit could become a "recipe for a financial crisis" if opaque ratings, aggressive leverage, and illiquid structures are not managed effectively. This analysis examines governance failures, valuation challenges, and regulatory responses in these markets, drawing on recent case studies and industry trends.

Governance Failures: The Case of Easterly RocMuni

One of the most illustrative examples of governance shortcomings in private credit is the collapse of the Easterly RocMuni High Income Municipal Bond Fund. In 2025, a class-action lawsuit alleged that the fund inflated bond prices and overinvested in illiquid assets, leading to a "shocking destruction of wealth" for investors.

The fund's net asset value (NAV) within months, . The complaint highlighted "materially false and misleading" valuations of distressed municipal bonds, underscoring the challenges of pricing assets in markets with infrequent trading and limited transparency. This case exemplifies how weak governance can exacerbate liquidity mismatches and erode investor trust.

Similarly, the 2019 collapse of the Woodford Equity Income Fund, attributed to a liquidity mismatch between illiquid assets and redemption terms, reinforces the fragility of funds reliant on opaque valuation practices. These incidents reveal a recurring theme: when institutional oversight fails to account for the unique risks of illiquid assets, the consequences can be catastrophic.

Due Diligence Shortcomings and Valuation Risks

Valuing illiquid assets-such as private company shares, small-cap stocks, or high-yield municipal bonds-poses inherent challenges. Infrequent trading, asymmetric information, and the absence of clear benchmarks create fertile ground for disputes and legal risks. For instance, , which defer interest payments in exchange for higher future debt burdens, have introduced new risks in high-interest-rate environments. These arrangements can delay recognition of credit deterioration, compounding losses when defaults occur.

The U.S. Securities and Exchange Commission (SEC) has acknowledged these risks, adopting in December 2020 to strengthen valuation policies for investment advisers. These rules mandate rigorous testing of valuation methodologies and enhanced oversight of pricing services. However, enforcement remains inconsistent. The Visium Asset Management case, where mispricing of illiquid assets led to criminal and regulatory actions, demonstrates the consequences of inadequate due diligence.

Regulatory Scrutiny and Systemic Implications

Regulators have increasingly focused on the systemic risks posed by private credit and illiquid assets. The Federal Reserve and Bank of England have warned about liquidity mismatches and interconnectedness in these markets, which could amplify stress during downturns. For example, when private credit funds sell troubled loans, they often fetch steep discounts, compounding investor losses and challenging liquidity for funds with redemption clauses.

The opacity of private credit-lack of public disclosure on borrower identities, loan terms, and valuation practices-further complicates oversight. As one industry report notes, "the industry's structural complexity and lack of robust secondary markets increase litigation risks." This opacity also creates conflicts of interest, particularly in partnerships with banks and across capital structure layers, which require transparent investor treatment.

Conclusion: A Call for Enhanced Governance

The Easterly and Woodford cases, along with broader industry trends, underscore the urgent need for stronger governance frameworks in private credit and illiquid asset markets. Institutional investors must adopt more rigorous due diligence processes, including stress-testing valuations and diversifying exposure to mitigate liquidity risks. Regulators, meanwhile, should enforce stricter disclosure requirements and ensure pricing services adhere to standardized methodologies.

As private credit continues to grow, the lessons from recent failures cannot be ignored. Without systemic reforms, the risks of another crisis-driven by governance lapses and valuation misjudgments-remain alarmingly high.