SEC Pursues Multi-Strat Manager for Claiming Safety and Diversification

The SEC has initiated enforcement proceedings against a multi-strategy fund-of-funds manager for selling his funds to older, conservative investors concerned with liquidity. The SEC alleges that the Respondent marketed the funds as highly diversified and non-correlated strategies because the funds invested in many underlying funds and managers. The SEC alleges that more than 50% of the assets were invested with two managers and that many of the strategies were similar. The funds ultimately suspended redemptions because two of the underlying fund managers (including Madoff) were frauds. The SEC alleges that several of the Respondent’s marketing representations contradicted specific risk disclosure in the PPMs. Among the several violations alleged include violations of the compliance rule (206(4)-7) for failing to adopt policies and procedures to determine “when it would be suitable clients to invest in complex hedge fund products, particularly for those clients that were unsophisticated, elderly, on limited incomes, and/or risk-averse.”

OUR TAKE: Suitability is often a retrospective determination. Even if a fund sponsor believes that the strategy is safe and diversified, the regulators and the courts will judge that determination after losses occur.

http://www.sec.gov/litigation/admin/2010/33-9139.pdf