In many situations, the interests of hedge fund managers and investors diverge.  See generally “Ernst & Young’s Sixth Annual Global Hedge Fund Survey Highlights Continued Divergence of Expectations between Managers and Investors,” Hedge Fund Law Report, Vol. 5, No. 44 (Nov. 21, 2012).  Recognizing this – and recognizing the insufficiency of the law to effectively mitigate the divergence – managers and investors have developed tools to align interests.  One such tool is the pay-for-performance concept embodied in the performance fee or allocation common to hedge fund structures.  See “SEC Adopts Final Rules Governing the Payment of Performance Fees to Registered Hedge Fund Managers,” Hedge Fund Law Report, Vol. 5, No. 9 (Mar. 1, 2012).  Another tool is manager co-investment or “skin in the game.”  The idea here is for the manager to put his money where his mouth is by making the same investments as investors.  Indeed, many hedge fund PPMs contain language to the effect that the principals of the management company have invested a “substantial portion of their net worth” in the funds.  See “Investments by Hedge Fund Managers in Their Own Funds: Rationale, Amounts, Terms, Disclosure, Duty to Update and Verification,” Hedge Fund Law Report, Vol. 3, No. 21 (May 28, 2010).  However, from time to time, a manager’s claims with respect to skin in the game are at odds with the facts.  The SEC is attuned to the potential dissonance between representations and reality, particularly in hedge fund marketing materials.  In June of last year, the SEC settled administrative proceedings against a hedge fund manager alleging, among other things, misleading statements regarding skin in the game.  See “SEC Sanctions Quantek Asset Management and its Portfolio Manager for Misleading Investors About ‘Skin in the Game’ and Related-Party Transactions,” Hedge Fund Law Report, Vol. 5, No. 23 (Jun. 8, 2012).  The SEC recently settled another administrative action based on similar allegations, this time in connection with investments in collateralized debt obligations (CDOs).  This article describes relevant factual and legal points from the more recent settlement.  For a discussion of another matter involving overlapping facts, see “Implications of the Second Circuit’s Decision to Reinstate Breach of Contract and Gross Negligence Claims Brought against a CDO Manager,” Hedge Fund Law Report, Vol. 5, No. 33 (Aug. 23, 2012).