Do You Have Skin in the Game?

skin in the game

If you tell investors that you have skin in the game, you need to have skin in the game. For the second time this year, the SEC has brought an enforcement action against a private fund for falsely informing investors that the Managers had skin in the game. Most investors want a manager’s executives to invest in the fund right alongside investors.

Don’t say it, if you don’t do it.

The most recent enforcement action was brought against Aladdin Capital Management, Aladdin Capital and a former executive, Joseph Schlim. All parties consented to the administrative orders, but neither admit nor deny the charges.

“[w]hy is an investor better off just investing in Aladdin sponsored CLOs and CDOs?” Aladdin answered by emphasizing that the “most powerful response I can give to your question is that Aladdin co-invests alongside MAST investors in every program. Putting meaningful ‘skin in the game’ as we do means our financial interests are aligned with those of our MAST investors.”

An inherent conflict in the transactions is that Aladdin was collecting a placement fee for much of the equity going into the deal. By reserving 10% for itself, it was losing 10% of its potential commission. Presumably, they could have taken that commission as equity in the deal instead of cash. But the product was packed with sub-prime mortgages and garbage debt.

Back in May, the SEC brought a similar administrative proceeding against Quantek Asset Management LLC for misleading investors about whether its executives had personally invested in its fund.

The two cases show that the SEC is will not tolerate misrepresentations in this area:

“If you sell an investment with the pitch that you are co-investing and have ‘skin in the game,’ then you better actually have ‘skin in the game…. Such a representation by an investment adviser or broker-dealer is an important consideration to investors in complex products.” Robert Khuzami, Director of the SEC’s Enforcement Division