Failure to Conduct Diligence Can Lead to SEC Sanctions

SEC Enforcement Logo

If you advertise that you have due diligence process, you had better follow that process. The Securities and Exchange Commission brought an administrative proceeding against an investment adviser for failing to follow its advertised due diligence program.

The Hennessee Group promoted its process for evaluating and selecting hedge funds as the “Five Level Due Diligence Process.” They represented to clients and prospective clients that they would not recommend investment in hedge funds that did not satisfactorily complete all five levels of its due diligence evaluation. The Hennessee Group routinely touted the excellence and rigor of the process.

According to the SEC’s order, approximately 40 clients invested millions of dollars in the Bayou hedge funds from February 2003 through August 2005 after the Hennessee Group recommended those investments. Most of the money was lost by Bayou’s principals, who defrauded their investors by fabricating Bayou’s performance. The SEC charged the managers of the Bayou hedge funds with fraud in 2005.

“With regard to Bayou, Hennessee Group, at Gradante’s direction, failed to perform two elements of the due diligence evaluation that Hennessee Group had told its clients and prospective clients that it would do: (1) a portfolio/trading analysis; and (2) a verification of Bayou’s relationship with its purported independent auditor. By not conducting the entire due diligence evaluation that it had advertised, and by failing to disclose to clients that its evaluation of Bayou deviated from its prior representations, Hennessee Group and Gradante rendered the prior representations about the due diligence process materially misleading and breached their fiduciary duties to Hennessee Group’s clients.”

To resolve the matter, the Hennesse Group agreed to adopt procedures to ensure proper disclosure of its evaluation processes. They also had to pay $549,000 in disgorgement of its advisory fees related to Bayou, and to pay a civil penalty of $100,000.

These seems like a great example of the consequences for failure to follow your policies and procedures.

See:

Subscribe

Subscribe to have new articles from Compliance Building sent to your inbox.

,

9 Responses to Failure to Conduct Diligence Can Lead to SEC Sanctions

  1. Peter Teuten April 24, 2009 at 11:53 am #

    This is the tip of the iceberg. Look under the hood of a great majority of IA’s and you will find what could only be described as sloppy procedures and a lack of defined processes for Due Diligence.

    For the most part IA’s live on spreadsheets. Beware the spreadsheet.

    The spreadsheets are snapshots, they do not, nor will they ever, support a continuous systematic process.

    If the SEC had the number of field auditors it needed, we would be reading many more stories exactly like this on a daily basis

    ~Peter

    • Doug Cornelius April 24, 2009 at 1:08 pm #

      Peter –

      I am sure that more of what you talk about will come out.

      The Hennessee Group case was a little unique. They touted their due diligence process with advertisements. By failing to follow their diligence process in their advertisement, they rendered their advertisement untrue.

      Unfortunately for them, one of the choices that they failed to diligence was a fraud. With a loss their failure came to light.

      • God February 23, 2011 at 9:16 pm #

        $500 000 fee indicates an administrative “slap on the hand”.
        I am sure the Hennessee Group did not “advertise”. Where did you come up with that lie. I suggest you read (if you know how to) the entire report.

        • Doug Cornelius February 23, 2011 at 9:32 pm #

          God is that you? It’s me Doug. Why do you think I can’t read?

          You are right in the sense that they did not publicly advertise. But the SEC used the same term:

          “With regard to Bayou, Hennessee Group, at Gradante’s direction, did not perform several key elements of its advertised due diligence practices.”

Trackbacks/Pingbacks

  1. Web Watch: Best Blog Posts and Columns For the Week Ending April 24 - April 24, 2009

    […] COMPLIANCE BUILDING (April 24, 2009): Failure to Conduct Diligence Can Lead to SEC Sanctions If you advertise that you have due diligence process, you had better follow that process. The SEC brought an administrative proceeding against an investment adviser for failing to follow its advertised due diligence program. […]

  2. The fi360 Fiduciary Score Methodology | Compliance Building - May 4, 2009

    […] If you are an investment adviser, you need to conduct your diligence on the investment choices you distribute. As we saw in the Hennessee Group administrative action, if you promote your diligence program you have to actually follow that program. [Failure to Conduct Diligence Can Lead to SEC Sanctions] […]

  3. CCOutreach | Compliance Building - June 17, 2009

    […] was some discussion of the Hennessee case where the SEC brought action for an investment adviser failing to conduct diligence. There seemed […]

  4. SEC Attacks the Rating Agencies | Compliance Building - May 12, 2010

    […] case reminds me of the Hennessee Group action where the SEC brought an action against a hedge fund for failing to conduct adequate […]

  5. SEC Censure for Failing to Conduct Due Diligence | Compliance Building - May 13, 2010

    […] into the investment. They had promised to conduct due diligence. We saw a similar action by the SEC against the Hennessee Group for their failure to conduct their promised due […]