SEC Administrative Proceeding Cites Violation of Advisers Act Due to Insurance Premium Allocation Practices

The SEC has commenced enforcement proceedings against a large greenwich based Hedge Fund siting violations of section 206(2), 206(4) and 206(4)-8 of the Investment Advisers Act in part resulting from inadequate insurance premium allocation methodology.

Section 206 of The Investment Advisers Act of 1940:

(2) to engage in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client;

(4) to engage in any act, practice, or course of business which is fraudulent, deceptive, or manipulative. The Commission shall, for the purposes of this paragraph (4) by rules and regulations define, and prescribe means reasonably designed to prevent, such acts, practices, and courses of business as are fraudulent, deceptive, or manipulative.

While fund documents allowed for the various funds to bear insurance-related premiums which are related to the affairs of the fund, from 2008 to 2013, the client allocated 100% of the premium costs to the funds as a fund expense. In 2013 the fund received a recommendation from a third party consultant to reconsider its premium allocation practices. As a result of the audit, the fund addressed the issue, changed its methodology and even reimbursed $733,012 in retroactive insurance costs to the various funds.

Despite this, the SEC sited that the fund acted in contravention to its governing documents and cited violations of the Advisers Act.

Our view: Clients should have clear and definitive guidelines regarding insurance premium allocation methodology and adhere to those guidelines. Additionally, proper disclosure in the fund documents is paramount and identifying which insuring agreements of a joint insured policy or more importantly stand alone policies address risks which are separate and distinct from fund management affairs.

Click here for a copy of SEC Administrative Proceeding.

Louis D’Agostino is the President and Financial Services Practice Leader of Iron Cove Partners. Mr. D’Agostino is responsible for the oversight and management of Iron Cove’s Financial Institutions Practice which is dedicated to addressing the unique and complex risk management needs of companies engaged in the arena of financial services. i.e. Private Equity Funds, Hedge Funds, Investment Advisers, Securities/Dealers, Mutual Funds and the like. Mr. D’Agostino & his team currently serve as insurance adviser to some of the world’s largest Asset Managers and Financial Institutions.