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SEC charges Connecticut-based adviser with CDO misstatements

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The Securities and Exchange Commission (SEC) has charged a Connecticut-based investment adviser with falsely stating to clients that it was co-investing alongside them in two collateralised debt obligations (CDO).

The SEC’s investigation found that Aladdin Capital Management’s co-investment representation was a key feature and selling point for its Multiple Asset Securitised Tranche (MAST) advisory programme involving CDOs and collateralised loan obligations (CLOs).

For example, Aladdin Capital Management asked in one marketing piece: “Why is an investor better off just investing in Aladdin sponsored CLOs and CDOs?” It then emphasised that the “most powerful response I can give to your question is that Aladdin co-invests alongside MAST investors in every program. Putting meaningful ‘skin in the game’ as we do means our financial interests are aligned with those of our MAST investors.”

Aladdin Capital Management in fact made no such investments in either CDO, and its affiliated broker-dealer Aladdin Capital collected placement fees from the CDO underwriters.

Aladdin Capital Management and Aladdin Capital agreed to pay more than USD1.6m combined to settle the SEC’s charges. One of the firms’ former executives Joseph Schlim agreed to pay a USD50,000 penalty to settle charges against him for his role in the misrepresentations.

“If you sell an investment with the pitch that you are co-investing and have ‘skin in the game,’ then you better actually have ‘skin in the game,’” says Robert Khuzami, director of the SEC’s enforcement division. “Such a representation by an investment adviser or broker-dealer is an important consideration to investors in complex products.”

According to the SEC’s orders instituting settled administrative proceedings, Aladdin Capital Management’s clients committed to investing in upcoming CDO deals that would be managed by the firm. Aladdin Capital Management inaccurately informed a municipal retirement plan, a pension plan, and an individual entrepreneur that it would co-invest alongside them. After those three clients invested in the two CDOs, Aladdin Management erroneously continued to inform clients from 2007 to 2010 that the firm had skin in the game.

According to the SEC’s order against Schlim, he was significantly involved in the MAST programme on a day-to-day basis. He made sales calls to potential clients and negotiated with CDO and CLO underwriters about the amount of equity in those securities that Aladdin Capital could place with customers or purchase for itself. Schlim also negotiated the placement fees to be received by Aladdin Capital for securing MAST investments in equity tranches of each CDO or CLO.

The SEC found that Schlim knew that Aladdin used the co-investment representation as a significant marketing feature in its pitches to clients, but he failed to take any action to ensure that such representations were accurate when they were made. As the CFO of Aladdin, Schlim was responsible for reserving funds for Aladdin to co-invest alongside its MAST clients, yet he failed to ensure that funds were reserved or allocated for any co-investments alongside clients in either CDO.

Aladdin Capital Management and Schlim agreed to cease-and-desist orders without admitting or denying the SEC’s allegations. The Aladdin entities agreed to jointly pay USD900,000 in disgorgement, USD268,831 in prejudgment interest, and a USD450,000 penalty. Schlim agreed to pay a USD50,000 penalty.

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