Investment Advisers Settle SEC Charges for Improper Hedge Clauses

Two affiliated investment advisers settled SEC charges for including misleading liability disclaimers in advisory agreements and for failing to subject client assets to independent verification.

According to the cease-and-desist Order, the firms required retail clients to sign agreements containing "hedge clauses" which included statements regarding the scope of their unwaivable fiduciary duty. The SEC found that this language could lead clients to incorrectly believe they had waived non-waivable causes of action for misconduct by the adviser. Additionally, the SEC found that the agreements improperly permitted the assignment of advisory contracts without client consent.

The SEC stated that the firms had custody of client assets because their agreements authorized them to withdraw or direct disbursements. Despite having custody, the SEC alleged the firms failed to obtain verification of client funds and securities by an actual examination by an independent public accountant for years 2019 through 2024. The SEC also noted that the firms failed to implement policies and procedures reasonably designed to prevent these violations, as the firms' compliance manuals explicitly prohibited the very clauses that appeared in their client agreements.

As a result, the SEC charged the firms with violating IAA Sections 205(a)(2) ("Investment advisory contracts"), 206(2) ("Prohibited transactions by investment advisers"), as well as Rules 206(4)-2 ("Custody of Funds or Securities of Clients by Investment Advisers") and 206(4)-7 ("Compliance procedures and practices") thereunder.

The firms agreed to a cease-and-desist Order, a censure, and agreed to pay civil money penalties totaling $150,000.