## Facts

- Hennessee Group LLC was an SEC-registered investment adviser and hedge-fund consultant that recommended and monitored hedge-fund investments for clients, including individuals and institutions.
- The firm marketed itself as using a “Five Level Due Diligence Process” and represented that it would not recommend hedge funds that did not satisfy all phases of that process.
- Charles J. Gradante, the firm’s co-founder and chief investment officer, supervised the Bayou Funds due-diligence evaluation and was responsible for the recommendation decision.
- Beginning in December 2002, Hennessee Group recommended hedge funds managed by Bayou Management, LLC to clients; by mid-2005, about 40 clients invested more than $56 million, and the firm received over $500,000 in advisory fees connected to those referrals.
- For the Bayou Funds, Hennessee Group did not conduct the advertised portfolio/trading analysis based on prime-brokerage reports; Bayou refused to provide trading data, and the firm relied on Bayou’s unverified representations and reported returns.
- The firm failed to verify Bayou’s auditor relationship and did not resolve conflicting information about the identity and purported changes of outside auditors.
- The firm did not adequately investigate information suggesting a conflict involving Bayou’s back-office head and the purported audit firm.
- Hennessee Group did not disclose to clients and prospective clients that it had not followed key parts of its advertised due-diligence process for the Bayou Funds.
- In August 2005, Bayou announced it was shutting down; later information indicated Bayou’s principals had falsified performance and issued financial statements with a fake auditor opinion, and most client investments were lost.

## Issues

1. Whether an investment adviser violates Investment Advisers Act § 206(2) by representing that it performs a defined, rigorous due-diligence program, while failing to perform key elements and not disclosing those deviations when recommending a hedge fund.
2. Whether misstatements and omissions about the scope and quality of an adviser’s due diligence can constitute a practice operating as a fraud or deceit on clients or prospective clients under § 206(2), without proof of scienter.
3. What remedies the SEC may impose in a settled administrative cease-and-desist proceeding for § 206(2) violations.

## Decision

- The SEC instituted a public administrative and cease-and-desist proceeding under Advisers Act §§ 203(e), 203(f), and 203(k), resolved by settlement on a without-admit-or-deny basis (except jurisdiction).
- The SEC found Hennessee Group and Gradante willfully violated Advisers Act § 206(2).
- The SEC determined respondents misrepresented that recommended hedge funds would pass all five levels of due diligence, while failing to perform key components (including the portfolio/trading analysis and adequate auditor verification) and failing to disclose those omissions.
- The SEC ordered respondents to cease and desist from committing or causing any violations and any future violations of § 206(2).
- The SEC imposed sanctions including censure, civil monetary penalties, and undertakings designed to improve compliance.

## Legal Principles

- Advisers Act § 206(2) prohibits an investment adviser from engaging in any transaction, practice, or course of business that operates as a fraud or deceit upon any client or prospective client.
- Liability under § 206(2) does not require scienter; negligent misrepresentations or omissions may be sufficient.
- An SEC-registered investment adviser owes fiduciary duties, including full and fair disclosure of material facts and a duty of care in making recommendations.
- Marketing claims about an adviser’s due-diligence process may be material; failing to perform advertised diligence, or failing to disclose material departures from it, can breach fiduciary duties and violate § 206(2).
- Red flags bearing on the integrity of a recommended investment (such as inability to obtain trading data, unresolved auditor discrepancies, or indications of conflicted controls) require reasonable inquiry consistent with the adviser’s representations and fiduciary obligations.

## Conclusion

The SEC concluded that Hennessee Group and its principal violated Advisers Act § 206(2) by misleading clients and prospective clients about the rigor and completion of the firm’s stated hedge-fund due diligence when recommending the Bayou Funds, and it imposed a cease-and-desist order, censure, penalties, and compliance undertakings through a settled administrative order.


In re Hennessee Grp. LLC, Investment Advisers Act Release No. 2871 (SEC 2009)