Three Steps Hedge Fund Managers Can Take to Avoid Liability for Related Party Conflicts of Interest

The interests of hedge fund investors and managers are not always in perfect alignment.  One of the principal conflicts with which investors are concerned is the investment of fund assets in companies in which the manager or one of its affiliates has a financial or other interest; consciously or unconsciously, such interests are thought to color the manager’s judgment.  For this reason, hedge fund investors and regulators expect managers to disclose (in hedge fund offering documents) all material facts necessary to understand the incentives informing a manager’s investment decision-making.  A recent SEC enforcement action demonstrates the agency’s commitment to identifying and interdicting undisclosed conflicts of this nature.  Specifically, the SEC’s action alleges that a registered fund manager invested fund assets in two high-risk private technology companies he founded without disclosing the attendant conflicts of interest to investors, and in contravention of fund offering documents which stated that he would invest fund assets primarily in publicly traded securities.  This article describes the factual allegations, causes of action and remedies sought by the SEC.  This article also provides three recommendations for hedge fund managers aiming to avoid enforcement activity for failing to disclose related party conflicts of interest.

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