The SEC charged New York-based investment adviser Hennessee Group LLC and its principal Charles J. Gradante with securities law violations for “failing to perform their advertised review and analysis before recommending that their clients invest in the Bayou hedge funds that were later discovered to be a fraud,” according to an SEC announcement .
In a settled administrative proceeding , the SEC issued an order finding that Hennessee Group and Gradante did not perform key elements of the due diligence that they had represented they would conduct prior to recommending investments in the Bayou hedge funds.
The SEC also said that they failed to conduct a reasonable investigation into red flags concerning Bayou. “Hennessee Group and Gradante routinely represented to clients and prospective clients that they would not recommend investments in hedge funds that did not satisfy all phases of their due diligence evaluation,” according to an announcement of the action.
“Forewarned is forearmed — investment advisers must make good on their promises or face the consequences of vigorous SEC enforcement action,” said Robert Khuzami, Director of the SEC’s Division of Enforcement.
“As the Commission found, these investment advisers failed to honor the representations they made to their clients and did not disclose these material departures from their advertised services,” said Antonia Chion, Associate Director of the SEC’s Division of Enforcement. “The advice that clients receive from hedge fund consultants is especially critical when the hedge funds are neither regulated nor transparent.”
According to the Commission'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 through trading or dissipated by Bayou's principals, who defrauded their investors by fabricating Bayou's performance in client account statements and year-end financial statements. The SEC charged the managers of the Bayou hedge funds with fraud in 2005 (see Bayou Founder Pleads Guilty to Fraud ).
The Commission's order finds that Hennessee Group and Gradante failed to conduct the portfolio and trading analysis that it had advertised to clients. "Instead of analyzing Bayou's results and processes through a review of Bayou's historical trading methods to determine whether the fund was, in fact, successfully executing its purported day-trading strategy, Hennessee Group and Gradante decided not to perform any analysis after Bayou refused to produce its trading data," the SEC said. The SEC said that Hennessee and Gradante instead "relied entirely on Bayou's uncorroborated representations about its strategy and its purported rates of return".
The Commission's order also finds that despite conflicting reports from Bayou about the identity of their independent auditor, Hennessee Group and Gradante failed to verify Bayou's relationship with its auditor. "In fact, the accounting firm that purportedly conducted Bayou's annual audit was a non-existent entity fabricated by one of Bayou's principals, who was identified in publicly available state accountancy board records as the registered agent for the bogus accounting firm," according to the SEC.
According to the Commission's order, Hennessee Group and Gradante also failed to respond to red flags concerning Bayou that came to their attention while they were monitoring Bayou on behalf of their clients. In particular, the SEC says that the two "failed to inquire or investigate when Bayou provided contradictory responses regarding the identity of its auditor or to adequately inquire about a rumor that one of Bayou's principals was affiliated with Bayou's purported outside auditing firm."
The Commission's order finds that Hennessee Group and Gradante violated Section 206(2) of the Advisers Act. The order requires Hennessee Group and Gradante to pay $814,644.12 in disgorgement and penalties, and to cease and desist from committing or causing further violations. The parties also are required to adopt policies to ensure adequate disclosures in the future and to provide copies of the Commission's Order to all current and prospective clients for a period of two years.
Hennessee Group and Gradante consented to the entry of the Commission's order without admitting or denying the findings, according to the SEC announcement.
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