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April was a busy month for the SEC. As well as fining a fund manager for deficiencies over fees and expenses, the SEC also agreed to settle proceedings with an energy-focused private equity fund manager. The case related to marketing materials distributed by the manager for a private fund that omitted information about the character of prior investments thereby rendering the marketing materials misleading and highlights the need to make sure policies and procedures are adequate and operate as intended.
False and misleading advertising
Before founding the fund manager, the principals managed private funds investing in direct drilling investments, direct private equity investments and private fund investments. In marketing a new private fund, the fund manager placed emphasis on the principals’ previous investments. The marketing materials stated the fund would only invest in direct drilling investments, private equity investments and midstream assets, either directly or through private equity investments while also stating investments in other private funds wouldn’t be a part of the investment strategy. These marketing materials were then distributed to over 120 potential investors.
The marketing materials provided to potential investors purported to reflect the investment performance of early stage direct drilling investments in the private funds managed by the principals prior to founding the manager. However, in calculating the performance, the manager categorized a previous investment in a private fund as an early stage direct drilling investment. The particular private fund investment had “strong, positive performance” and the fund itself had a return on investment of 10.9x. However, the early stage direct drilling investments in the portfolio managed by the manager’s principals had a much lower return on investment.
As you’d expect, the fund manager had in place a compliance manual and code of ethics. The compliance manual included policies and procedures that prohibited the fund manager and its employees from publishing, circulating or distributing any advertisement that contained any untrue statement or omission of a material fact or which was otherwise false or misleading.
The manual also included policies and procedures prohibiting the use of performance results in marketing materials that were false or misleading, including any misleading depictions of investment performance that led to direct or indirect implications or inferences arising out of the context of the marketing materials.
Violation of the Advisers Act
According to the SEC, the fund manager violated Section 206(4) of the Advisers Act and Rule 206(4)-7 thereunder, which require a registered investment adviser to, among other things, “adopt and implement written policies and procedures reasonably designed to prevent violation” of the Advisers Act and its rules.
An interesting note to this action is, although “negligence” is enough to establish a violation of 206(4) and Rule 206(4)-7, the SEC specifically noted the violation was wilful and found the manager “wilfully” violated the Advisers Act. The Act forbids firms to directly or indirectly publish, circulate, or distribute an advertisement which contains any untrue statement of material fact, or which is otherwise false or misleading.
Whether the fund manager purposefully tried to circumvent the rules or not, firms can violate the Adviser Act by “negligence” alone so it’s important to make sure your policies and procedures are tightly in place.
How we can help
Now more than ever, firms have a duty to protect their customers. We offer a number of related services to make sure you have everything in place. If you can’t find what you’re looking for below, get in touch.
- Design and review policies and procedures
- Review marketing materials
- Mock SEC exam
- Targeted testing of compliance policies and procedures
