The U.S. Securities and Exchange Commission adopted a new rule that prohibits investment advisers to pooled investment vehicles from defrauding investors and potential investors. The rule, which clarifies the Commission's authority to bring enforcement actions against investment advisers, applies to advisers of registered and unregistered investment companies, including hedge funds, private equity funds, venture capital funds, and other pooled investment vehicles, including heavily regulated mutual funds. The rule does not alter the Commission's jurisdiction over off-shore advisers in their interactions with non-US investors.


The US Court of Appeals for the District of Columbia Circuit, in 2006, said that the Commission lacked authority to count individual investors in certain pooled investment vehicles (e.g., hedge funds) as "clients" of investment advisers for the purpose of determining whether an investment adviser must register with the Commission. That is, the court said that for purposes of Sections 206(1) and 206(2) of the Investment Advisers Act - the anti-fraud statutes - the client is the investment pool itself, not the individual investors in the pool. The court effectively threw out the Commission's rule, and said that the Commission must treat pooled funds as single clients, no matter how many people invest in a single fund.

As a by-product, the court's ruling cast doubt on the Commission's ability to commence enforcement proceedings against investment advisers who defraud investors in these investment pools. In recent years, the Commission has commenced enforcement actions under Sections 206(1) and 206(2) of the Advisers Act against investment advisers who allegedly defrauded investors in investment pools (not just the pools themselves).

The new rule bases its authority in Section 206(4) of the Advisers Act, which makes it unlawful for advisers to engage in any act or practice that is "fraudulent, deceptive or manipulative." This section, which is not limited to conduct aimed at clients or potential clients of registered investment advisers, authorizes the Commission to adopt rules reasonably designed to prevent such abuses.

Rule 206(4)-8

Rule 206(4)-8 prohibits investment advisers of pooled investment vehicles from:

  • making false or misleading statements to investors or prospective investors in these pools; or
  • otherwise defrauding those investors.

The rule does not further define fraud. Rather, the Commission stated unambiguously that it intended "to prohibit all fraud on investors in pools managed by investment advisers". The Commission said that the nature of an investment adviser's duty to "communicate without false statements" is well-defined under federal securities laws as interpreted by the Commission and the courts.

Scope of the Rule 

Investors and prospective investors. The Commission's staff was concerned that existing rules would limit the Commission's ability to allege that advisers committed fraud against investors in pooled vehicles. For example, existing rules did not cover fraud in account statements sent to existing investors.

The rule applies to fraud conducted against investors and potential investors in pooled investment vehicles. It covers, for example, false or misleading statements in account statements delivered to existing investors, as well as statements made to potential investors in private placement memoranda, offering circulars or responses to "requests for proposals", electronic solicitations, and personal meetings arranged through capital introduction services. The Commission did not limit the rule to specific types of communications.

Unregistered investment advisers. The rule applies to both registered and unregistered investment advisers of investment pools.

Pooled investment vehicles. The rule applies to investment advisers of any registered investment company, and any privately offered investment pool that is exempt from registration under Section 3(c)(1) (beneficial ownership by not more than 100 persons) or Section 3(c)(7) (ownership limited to qualified purchasers) of the Investment Company Act.

Thus, the rule applies to investment advisers to hedge funds, private equity funds, venture capital funds, and other types of privately offered funds.

False and Misleading Statements

The rule prohibits investment advisers of pooled investment vehicles from making any false or misleading statement to any investor or prospective investor in the fund, or omitting to state any material fact necessary in order to make any of the statements made to the investor or prospective investor, under the circumstances, not misleading.

This standard is similar to other anti-fraud standards found elsewhere in the federal securities laws, such as Rule 10b-5 under the Securities Exchange Act of 1934. But, unlike Rule 10b- 5, the new rule applies to advisers regardless of whether the fund is offering, selling or redeeming securities. For example, the rule would prohibit fraud in reporting results, discussing strategies or describing the experience or credentials of the investment adviser, and practices involved in allocation of securities trades.

Prohibition of Other Frauds

The rule contains a catch-all prohibition of all types of fraudulent conduct, which is designed to address all kinds of fraud, even those that do not involve communications. For example, the rule would cover fraudulent practices involving investment opportunities or soft dollar allocation. Negligence Standard

The rule applies a negligence standard. That is, the Commission need not prove that the investment adviser committed fraud with scienter, or the intent to deceive.

Fiduciary Duties

The Commission said that the rule does not create any new fiduciary duties owed by investment advisers to investors or prospective investors of investment pools that are not otherwise imposed by existing law.

Private Right of Action

The rule does not create a private right of action. That is, only the Commission can commence an action against an investment adviser for violating the rule.