He points to Provident Royalties LLC, a private placement company which sold oil and gas interests and was accused by the SEC of running Ponzi schemes. Both RIAs and broker-dealers were told they should’ve seen the red flags, and more than 20 independent broker-dealers had to close their doors because of associated legal costs, he says.

Schlangen also cites Behringer Harvard REIT I, which was sued in September by an investor seeking class action status. The complaint alleges the large nontraded REIT masked poor performance by paying investors back with their own money. “Financial advisors should be aware and communicate to clients the difference between return of capital and return on capital,” he says.

Financial advisors should also get more attuned with the regulations because the JOBS Act will create a whole different category of alternative investments, he says. “This could unfortunately open the door for some rotten apples out there,” Schlangen says.
Schlangen notes that the Financial Services Institute and the National Society of Compliance Professionals are places to go to learn more about regulatory or compliance requirements.

Marina Lewin, head of sales for BNY Mellon’s Asset Servicing business in the Americas and leader of global sales for the company’s Alternative Investment Services (AIS) group, agrees that advisors should get to know the growing number of alternative investment regulations—many of which came out of the Dodd-Frank Act. “There’s a broad cross-section of change,” she says.

For example, managers of many hedge funds and private investment funds are now required to register with the SEC and file a quarterly “Form PF.” The 42-page document must include disclosures on strategy, liquidity, ownership and asset performance.  “The industry is not nearly as opaque as it was 10 years ago,” Lewin says.

She suggests that advisors select platforms only after rigorous due diligence that includes examining their structure to ensure they have separation of duties and knowing who the trading partner, prime broker and service providers are.

“The regulations may appear to be burdensome but the real driver is investment protection,” Lewin says. “Understand the risks of who you’re investing with.”

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