SEC’s Risk Alert Regarding Alternative Investments Due Diligence

Generally, when we think of investing, we think of stocks and bonds. Now, however, there seems to be an increasing trend for investment advisors to recommend alternative investments to their clients. Although there is no clear definition of alternative investments, these are non-traditional investments that can include tangible goods such as hedge funds, private equity, commodities, and many others.

Late last month the Securities and Exchange Commission (SEC) issued a Risk Alert pertaining to studies conducted over a six-year period by its staff. These studies were of investment advisors who offer alternative investments to their clients. Of particular concern to the SEC Staff was the due diligence processes of these advisors. Due to the nature of these investments, the SEC Staff’s primary purpose was to ensure that advisors who recommend or place these investments on behalf of their clients are enacting and maintaining a high level of due diligence. This can be more difficult than with traditional investments because they can include private investment opportunities or other offerings of greater complexity.
“Money continues to flow into alternative investments. We thought it was important to assess advisors’ due diligence processes and to promote compliance with existing legal requirements, including the duty to ensure that such investments or recommendations are consistent with client objectives,” said Drew Bowden, Director of the SEC’s Office of Compliance Inspections and Examinations.

Unlike some other investment practices, there are no clearly defined due diligence practices for non-traditional investments. During their observation, the SEC Staff did notice some positive trade practices that had not previously been noted. One such practice was that advisors were working harder to glean more accurate information from those managing these transactions in an effort to validate these alternative investments. The use of third parties to confirm information provided by said managers was one of the methods used to help establish the accuracy of information. Additionally, the practice of performing risk assessments and more comprehensive analyses of these investments, as well as those who manage them, helped advisors make more sound decisions on the part of their investors.

Although these are tremendous strides toward developing due diligence standards for alternative investments, the SEC Staff found several areas of concern. It was established that the annual reviews of some investment advisors did not include due diligence practices, even though many advisors had invested a good deal of their clients’ money in these types of investments. There was also a failure to have due diligence practices in place that varied from those mentioned in disclosures provided to clients. Additionally, it was observed that some of the marketing materials provided by these advisors could be construed as misleading.

The fiduciary responsibility that these investment advisors hold demands that they comport themselves in the most ethical manner possible. Each advisor needs to assess the client’s investment objectives and use that knowledge judiciously when selecting alternative investment opportunities. It is in the best interests of both the investor and the investment advisor to engage in superior due diligence practices. This not only safeguards transparency within the industry, but it also assists in maintaining integrity in the practice of capitalizing on alternative investments. In achieving these goals, investors can rely more readily upon their investment advisor or manager to choose options that are most likely to result in positive returns on their investments.

Blum Law Group represents clients who have been victimized by brokers. If you have been questions or concerns about alternative investments, please call 877-STOCK-LAW for your free consultation with the Blum Law Group.