The SEC recently brought one of its first enforcement actions under Rule 206(4)-8 of the Investment Advisers Act (the Fund Fraud Rule) in the case of SEC v. Rabinovich & Associates, L.P. The Fund Fraud Rule prohibits investment advisers to pooled investment vehicles such as hedge funds, mutual funds, private equity funds, and venture capital funds, from making false or misleading statements to investors or prospective investors, or failing to state material facts necessary to make statements to investors not misleading.

Unlike other antifraud rules, the Fund Fraud Rule requires a showing of negligence, not scienter (the intent to deceive, manipulate, or defraud), and applies to both registered and unregistered advisers. Further, it is not restricted to transactions such as the sale of securities. As a result, many commentators viewed this as granting the SEC very broad enforcement authority.

In Rabinovich, the SEC alleged the defendants operated an unregistered investment company and broker-dealer. The defendants raised over $2 million from more than 150 investors by purportedly making fraudulent statements claiming that the firm had positive performance, that the firm was a member of the NYSE and NASD, as well as listing an address on Wall Street. The firm was actually operated out of a “boiler room” located in Brooklyn, had consistently lost money, and was not a member of the NYSE or NASD.

This case has given some confidence to the market that the SEC does not intend to use the Fund Fraud Rule to commence enforcement actions against advisers for subtle or nuanced disclosure omissions.