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:
- SEC Administrative Proceeding In the Matter of Hennessee Group LLC and Charles J. Gradante (.pdf) Adm. Proc. File No. 3-13454 (April 22, 2009)
- SEC Charges Investment Adviser That Recommended Bayou Hedge Funds to Clients – SEC Press Release
- Failing To Conduct Due Diligence — An Investment Adviser Is Sanctioned by Thomas O. Gorman for SEC Actions
- SEC Press Release on the Bayou Funds fraud
- Hennessee Settles Bayou Case by Ianthe Jeanne Dugan in the Wall Street Journal
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
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.
$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.
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.”