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Heed the cautionary tale of the recent $1.6 million settlement against an RIA and its affiliated B-D that falsely claimed they co-invested in a fund
December 28, 2012 — 2:30 AM UTC by Guest Columnist Les Abromovitz
As investment advisors attempt to differentiate themselves from other firms, they often rely on folksy sayings to show how confident they are in their strategies. This practice can lead to danger. Advisors must be careful to avoid painting an inaccurate picture that will mislead potential clients — for instance, bandying about phrases such as “having skin in the game” or “eating your own cooking” if they’re not based on fact. See: With SEC coming down hard, TV and radio star RIA principal in San Diego makes his case to listeners.
On Dec. 17, the SEC charged Aladdin Capital Management LLC, a Stamford, Conn.-based investment advisor, with falsely stating to clients that it was co-investing along with them in collateralized debt obligations and collateralized loan obligations. The firm’s marketing materials assured investors that the firm co-invested in an advisory program involving CDOs and CLOs. The materials emphasized that the investment adviser’s financial interests were aligned with those of investors in the program and the firm had meaningful “skin in the game.” See: NAPFA conference yields valuable nuggets of practice-management and marketing advice.
Robert Khuzami, director of the SEC’s Enforcement Division, warned that when an advisor markets an investment with the pitch that the firm is co-investing, it must actually have “skin in the game” at the point in time in which the claim is made. Securities regulators know that claiming to have skin in the game is likely to influence prospective investors. The investment advisor and its affiliated broker-dealer agreed to pay more than $1.6 million to settle the SEC’s charges. A former executive for the firms also agreed to pay a hefty fine to settle the charges arising from the parties’ misrepresentations. See: The marketing naughty and nice list.
This wasn’t the first time that the SEC has taken issue with an advisor’s making a misleading skin-in-the-game claim. On May 29, the SEC found that Quantek Asset Management LLC, a Miami-based hedge fund advisor, misrepresented that its executives had personally invested in a Latin America-focused hedge fund. See: How far can RIAs go with advertisements?. The firm and its principals agreed to pay $3.1 million in total disgorgement and penalties to settle the charges.
The lesson to be drawn from this enforcement action applies to every investment advisor, even if the firm never attempts to market an advisory program featuring complex products like CDOs and CLOs. It is fairly common to see RIA advertisements claiming that the firm’s interests are aligned with those of clients. In most instances, the firm’s interests really are aligned with clients’, and the RIA does act in their best interests. If not, however, the advertisement is misleading, which violates RIA advertising rules. See: One-Man Think Tank: When Wall Street has investors’ 'best interests’ at heart, watch out.
It’s not just the much-used phrase “skin in the game” that can backfire on an advisor. Many advisory firms advertise that they “eat their own cooking” and that they invest in the same portfolios as their clients. There is nothing misleading about that marketing pitch unless the RIA does not follow the same recommendations that it gives to clients. In fact, some firms’ advisory contracts state specifically that they may take actions that differ from advice given to their clients.
No matter what figure of speech or marketing slant an RIA uses to woo clients, the firm should take note of its compliance obligations. Sections 206(1) and (2) of the Investment Advisers Act of 1940 make it unlawful for an investment advisor to employ any device, scheme, or artifice to defraud current and prospective clients. Furthermore, advisors must never engage in any transaction, practice, or course of business that operates as a fraud or deceit upon a client or prospective client.
Every adviser should make full disclosure of the risks associated with an investment strategy. It should be disclosed that clients’ money is at risk even when their advisors have skin in the game and eat their own cooking. It will be of little consolation to clients to know that their advisors’ nest eggs went down the drain along with their own.
Les Abromovitz, an attorney, can be reached at National Compliance Services Inc. by calling 561-330-7645, Ext. 213, or by e-mailing him at firstname.lastname@example.org. Les is the author of THE INVESTMENT ADVISOR’S COMPLIANCE GUIDE, which was published in March 2012 by the National Underwriter Co., a division of Summit Business Media. The book is available at http://www.nationalunderwriter.com/the-investment-advisor-s-compliance-guide-2.html.
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