Investment advisors who recommend hedge fund investments should be very careful to disclose all material agreements between the advisor and the hedge fund and hedge fund manager. In the case below an investment advisor recommend hedge fund investments to its clients without disclosing to such clients that the advisor was receiving a part of the performance fees that were paid to the hedge fund manager.
Advisors should also take note to the following two issues:
SEC jurisdiction over state registered investment advisors
Even though the advisor was registered with the California Securities Regulation Division and not the SEC, the SEC was able to take action under Section 206 (the anti-fraud provisions) of the Investment Advisers Act. Additionally the SEC was able to bring charges against the investment advisor under the Securities Act of 1933 and the Securities Exchange Act of 1934 (the “Exchange Act”). This shows that the SEC’s has quite a few methods to assert jurisdiction over non-SEC registered advisors.
Potential violations of broker registration requirements?
Although I have not yet had a chance to read the unreleased complaint, I am wondering why the SEC did not charge this group with violating the broker registration requirements. I think there is an argument that the investment advisory firm was acting as a broker. I checked FINRA’s broker check and the firm did not come up as a registered broker.
Section 15(a)(1) of the Exchange Act generally makes it unlawful for any broker or dealer to use the mails (or any other means of interstate commerce, such as the telephone, facsimiles, or the Internet) to “effect any transactions in, or to induce or attempt to induce the purchase or sale of, any security” unless that broker or dealer is registered with the Commission in accordance with Section 15(b) of the Exchange Act.
The release below can be found here.
U.S. SECURITIES AND EXCHANGE COMMISSION
Litigation Release No. 20737 / September 24, 2008
Securities and Exchange Commission v. WealthWise, LLC and Jeffrey A. Forrest, United States District Court for the Central District of California, Civil Action No. CV 08-06278 GAF (SSx)
SEC Charges California Investment Adviser With Committing Fraud While Recommending Hedge Fund to Clients
The Securities and Exchange Commission today charged a San Luis Obispo, Calif.-based investment adviser and its owner with fraud for failing to disclose a material conflict of interest when recommending that their clients invest in a hedge fund that made undisclosed subprime and other high-risk investments.
The SEC alleges that WealthWise LLC and its principal Jeffrey A. Forrest recommended that more than 60 of their clients invest approximately $40 million in Apex Equity Options Fund, a hedge fund managed by Salt Lake City-based Thompson Consulting, Inc. (TCI). According to the SEC’s complaint, WealthWise and Forrest failed to disclose a side agreement in which WealthWise received a portion of the performance fee that Apex paid TCI for all WealthWise assets invested in the hedge fund. From April 2005 to September 2007, WealthWise received more than $350,000 in performance fees from TCI. Apex collapsed in August 2007, and WealthWise clients lost nearly all of the money they invested.
The SEC’s complaint, filed in federal district court in Los Angeles, charges WealthWise and Forrest with violating Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and Sections 206(1) and 206(2) of the Investment Advisers Act of 1940. The SEC seeks an injunction, an accounting of the total amount of performance fees WealthWise received from TCI, disgorgement of those fees, and financial penalties.
On March 4, 2008, the SEC filed a civil action in federal district court in Salt Lake City against TCI and three of its principals in connection with the collapse of Apex and another hedge fund.