An SEC administrative law judge found that an investment adviser and its owner, who represented themselves as independent, violated Sections 206(1) and (2) of the Investment Advisers Act by not disclosing their dealings with a hedge fund manager while recommending the fund manager to their clients. Independence has always been an essential requisite for an investment adviser, noted the law judge, and the owner of the advisory firm knew, should have known, or acted recklessly in representing the firm as an independent investment adviser to the public and in Forms ADV when he was requesting that the hedge fund manager pay the firm a fee, having the firm send the fund manager invoices, accepting the fund manager’s wire transfers, as well as other benefits from the hedge fund manager. These undisclosed actions come within the definition of schemes or artifice to defraud and transactions, practices, or course of business which operated as a fraud or deceit upon clients or prospective clients, concluded the law judge. (In the Matter of Montford and Company, Inc., Administrative Proceeding File No. 3-14536, April 20, 2012, Initial Decision of Brenda P. Murray, Chief Administrative Law Judge)
The law judge cited the US Supreme Court’s opinion in SEC v. Capital Gains Research, which held that the Investment Advisers Act reflects a congressional recognition of the delicate fiduciary nature of an investment advisory relationship, as well as a congressional intent to eliminate, or at least to expose, all conflicts of interest which might incline an investment adviser to render advice which was not disinterested. The statute, in recognition of the fiduciary relationship that advisers have to their clients, requires that advice be disinterested.
The law judge found that Form ADV contained materially false representations that the adviser did not receive any economic benefit from non-clients in connection with giving advice to clients; would disclose matters that could impact its ability to render objective advice; and did not accept fees from investment managers. In addition, the owner of the advisory firm accepted substantial gifts from the hedge fund manager and took actions to assist the manager that indicated he had an interest in the manager’s success; and bought securities recommended by the fund manager when he invested his retirement funds with the hedge fund, which subsequently waived the management fee.