This case involves a hedge fund portfolio manager who was the founder and partner at a capital market investment advisory firm. The portfolio manager authorized a client hedge fund to pay $7.5 million to purchase a basket of illiquid securities from a personal friend and outside business partner. This friend was hired by the manager’s firm as a managing director. The manager told his friend to divest these personal securities holdings when he took the job at the investment advisory firm because they overlapped with securities that the hedge fund was also invested. The manager did not tell the hedge fund or any partners or managers at the investment advisory firm that he had a financial stake in some of the same securities that were sold into the hedge fund. The manager personally benefited from the sale because after the hedge fund purchased the conflicted securities, his friend wired him over $2 million of the sales proceeds into his personal savings account. The SEC brought an action against the manager for violating the Investment Advisors Act.
Question(s) For Expert Witness
- If a portfolio manager participates in a principal transaction without telling the fund, does this violate his fiduciary duties and violate the Investment Advisors Act of 1940?
Expert Witness Response
Under the Investment Advisors Act of 1940, if a portfolio manager participates in a principal transaction, they must comply with requirements of full disclosure and obtain written client approval according to sections 206(2) and 206(3). A principal transaction is one where a portfolio manager acts for their own account and buys a security from a client account or sells a security to a client account. The reason principal transactions of portfolio managers are regulated by the Act is that they present conflicts of interest between the interests of the portfolio manager and the client. Generally, a portfolio manager owes a fiduciary duty to the fund. This means that a portfolio manager has a duty to the fund to place the fund’s interests before their own while exercising due care in the decision-making process. Since the portfolio manager in this case put his own interests before those of the fund, he most likely violated his fiduciary duty to the fund. Also, since the manager entered into a principal transaction where he was on both sides of the transaction as a buyer and seller without telling the fund and obtaining the written consent of the fund, he most likely violated the Investment Advisors Act.