SEC Files Enforcement Action Against an RIA for Allegedly Failing to Disclose Compensation Received from Private Investment Funds

June 22, 2009

On May 20, 2009, the U.S. Securities and Exchange Commission (“SEC”) announced that it had filed an emergency civil action charging Wealth Management LLC (registered investment adviser), James Putman (founder, majority owner and Chief Executive Officer of Wealth Management), and Simone Fevola (former President and Chief Investment Officer of Wealth Management) with engaging in a kickback scheme and other fraudulent conduct involving unregistered investment pools for which Wealth Management served as a General Partner or Managing Member and as the registered investment adviser responsible for managing the pooled assets.

In the complaint, the SEC alleges breach of fiduciary duty and fraud for misrepresenting the safety and stability of the two largest private funds managed by Wealth Management while placing their clients into these investments even though they were unsuitable for some of their clients. The SEC’s complaint also alleged, among other things, that Mr. Putman and Mr. Fevola each accepted at least $1.24 million in undisclosed payments derived from certain investments made within the private funds that were managed by Wealth Management, while continuing to cause clients to invest in these private funds.

The offering documents for the private investment funds disclose that Wealth Management would be compensated for managing the funds through a management fee based on a percentage of assets under management. Additionally, on four of the six funds that were managed by Wealth Management an annual “Incentive Allocation” of up to 10% (depending on the fund) of the annual profits could be paid to Wealth Management. No other forms of compensation were disclosed, and Wealth Management’s Form ADV indicated that the adviser and its associated persons did not receive any economic benefits from non-clients in connection with giving investment advice to clients. No references were made regarding the payments received from the investments made within the funds.

This case should serve as a reminder to a registered investment adviser that it has a fiduciary duty to its clients. As a fiduciary, a registered investment adviser has an affirmative duty of utmost good faith to act solely in the best interests of the client and to make full and fair disclosure of all material facts, especially when the registered investment adviser’s interest may conflict with the client’s interest. Not providing proper disclosure to advisory clients can result in violations to the anti-fraud provisions of the Investment Advisers Act of 1940. The receipt of any form of additional compensation received from any source other than the client when the adviser is recommending a security to a client is just one example of a conflict of interest that must be fully disclosed to the client.

Posted by Bryan Hill
Labels: Enforcement, Fiduciary, Hedge Funds