Investment Adviser Fined for Use of Hedge Clauses in Client Agreements

An investment adviser settled SEC charges for using misleading "hedge clauses" in client agreements and for Custody Rule violations.

In the Order, the SEC determined that an investment adviser violated its fiduciary duty by using hedge clauses in advisory and private fund partnership and operating agreements. The SEC said that the investment adviser used "liability disclaimer language" for "any action or inaction," with exceptions for "gross negligence" or "willful malfeasance" and violations of "applicable law." The SEC said that such language could lead investors to believe they had waived their legal rights, including non-waivable causes of action. 

The SEC further found that the investment adviser violated the Custody Rule by failing to timely deliver audited financial statements to investors in private funds it managed. The SEC said that the investment adviser relied on an "Audited Financials Alternative" in order to comply with the rule, but failed in seven instances to timely deliver the audited financials to the Funds' investors. The SEC found that during the relevant period, the investment adviser missed the 120-day deadline for distributing audited financial statements, sometimes by as much as 1,064 days.

The SEC found that the investment adviser violated Advisers Act Sections 206(2) and 206(4) ("Prohibited transactions by investment advisers") and Rules 206(4)-2 ("Custody of Funds or Securities of Clients by Investment Advisers") and 206(4)-7 ("Compliance procedures and practices") 

To settle the charges, the investment adviser agreed to (i) cease and desist from further violations, (ii) a censure and (iii) pay a civil monetary penalty of $65,000. The SEC noted that the investment adviser took remedial steps, including revising its custody procedures and removing the improper hedge clauses.