SEC SUES RIA FOR FAILING TO DISCLOSE PERFORMANCE FEE SHARING ARRANGEMENT WITH RECOMMENDED HEDGE FUND
The SEC filed a federal lawsuit against an investment adviser and its principal for failing to disclose to its clients that it received a portion of the performance fee from the manager of a hedge fund that the defendant recommended. According to the SEC, the defendant and the fund manager had entered into a side letter providing that the defendant would receive a percentage of the performance fee earned by the hedge fund manager with respect to the defendant’s clients in the fund. The SEC alleged that the defendant did not disclose the compensation arrangement. The hedge fund ultimately collapsed as a result of subprime investments and clients lost their assets.
OUR TAKE: As a result of the Goldstein case, the SEC staff was recently forced to take the position that a hedge fund manager need not comply with the Advisers Act’s solicitation rule, which requires disclosure of all compensation paid to solicitors. However, the SEC has not exempted solicitors that are registered investment advisers from disclosing all compensation that could affect their recommendations. One open question is whether the adviser was engaging in unregistered broker-dealer activities because the compensation received could be characterized as distribution fees.