SEC Issues Risk Alert Criticizing Advisors' Handling of Alternative Investments

Attorney Advising Disclaimer

The Security and Exchange Commission's National Exam Program issued a risk alter titled "Investment Adviser Due Diligence Processes for Selecting Alternative Investments and their Respective Managers," finding that inconsistent industry practices in handling complex alternative investments have put some investors at added risk.

In all, the SEC concluded that while advisers are enhancing and expanding due diligence processes, more work has yet to be done.

The SEC specifically provided the following warning indicators as signals for concern. The following actions, generally a description of what an adviser is not doing, may unduly increase risk.

Transparency should be provided

The SEC's alert notes that financial advisers throughout the industry vary their approaches to due diligence, finding that some managers provided ample position-level transparency of alternative investments while others did not share detailed information about these complex products.

Similarly, the alert states that some advisers recommended client assets be managed within a separate account to further this transparency, control and safeguard against misappropriation while others preferred a pooled investment structure.

The report cautions investors and advisers about managers unwilling to provide requisite transparency.

Return performance should correlate with strategies as described

Returns that do not correlate with known factors that are associated with a fund manager's described strategy may be a cause for concern.

Research and investment processes should be clear and controlled

For instance, some advisers independently verified alternative investment relationships and assets with third party service providers while others did not. Some advisers required independent administration and background checks as terms of investing in a private alternative investment fund while others did not.

Similar research regarding brokerage firm and registered representative histories appeared in some, but not all adviser strategies. Specifically, only some advisers made use of FINRA BrokerCheck to research firms and brokers before recommending and/or conducting business with them.

Research standards should be clear and background check reports a regular feature of due diligence.

Concentration should be manageable

The SEC cited alternative investment portfolio holdings that showed a high concentration in a single investment position as unnecessarily risky. Whether this failure of risk management is associated with an adviser or manager's lack of knowledge, passive errors or deliberate misconduct, significantly high concentration in one position may be a sign of poor or violative investment activity.

Similarly, the SEC again stressed that even alternative products should be explained in clear terms and promoted through transparent means.

Third party administrators, experienced auditors and fair valuation processes are a must

Under the operational heading, the NEP warned that a lack of third-party administrators or other independent service providers may be a red flag of potential conflicts of interest, such as compensation arrangements that may provoke an adviser into executing a strategy not in the best interests of the client.

Additionally, fair valuation processes and compliance programs should be transparent and explainable. No stone should be left unturned in the department of due diligence.

If you have invested with a financial adviser, fund manager, broker or firm whose failure to conduct adequate due diligence for alternative investments, complex products or any other investment opportunity and such omission has proven harmful to your interests, please call The Law Offices of Jonathan W. Evans & Associates at (800) 699-1881 for investigation and consultation.

Related Posts
  • After $13 Million in Penalties for 'Widespread Failure,' Oppenheimer Fined $500,000 for Supervisory and Suitability Gaps Read More
  • FINRA barred former Independent Financial Group (IFG) broker Brett Arthur Hartvigson of San Diego, California for refusing to cooperate with its investigation into allegations that were part of a complaint. In 2021, while associated with IFG, Brett Harvgi Read More
  • Stifel Nicolaus Failed to Detect Unsuitable Recommendations Despite Risk Policy, Says FINRA Read More