Skin in the Game

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Because I receive a live feed from the SEC, I get between 6 and 12 SEC press releases every day. Most deal with actions brought by the SEC against a variety of individuals and firms and most are, quite frankly, not worthy of further comment. But once in a while the SEC brings an action against an adviser that catches my attention. The December 17th press release – “SEC Charges Connecticut-Based Adviser for “Skin in the Game” Misstatements About CDOs” – was one such attention grabber.

In a nutshell, the adviser told clients and potential clients that management’s financial interests were completely aligned with their clients’ interests because they had skin in the game (e.g., management was co-investing alongside it clients). Alas, this was not true and hence the SEC action.

The reason this SEC action piqued my interest is because it is common for advisers to hedge funds to tout this same congruity of interests. In fact, I have written – at the behest of the client – in more than one hedge fund manager’s ADV Part 2A the following (or words to that effect):

“The managing member of [adviser] and members of his family have also invested in the various Funds. In order to create a strong congruity of interest between the management of the Funds and its investors, all investment professionals employed by [adviser] are required to invest in the Funds.”

There is certainly nothing inherently wrong in making this statement (otherwise I would not allow them to make it), but anyone who has made such a claim should check to make sure it is (still) accurate. Employees come and go, investments change and what was once the practice when the fund began may have morphed into something less than an absolute rule.