The SEC has initiated a civil enforcement action against a fund-of-funds manager for failing to disclose preferential treatment granted to one of its largest investors.  According to the SEC, the defendants granted the large investor preferential distribution rights via the feeder fund through which it was invested.  The SEC charges that the firm’s marketing materials failed to disclose the feeder fund’s preferential rights, claiming instead that all investors had equal redemption rights.  According to the SEC, the large investor, which represented 40% of assets, threatened to redeem when presented with a re-structuring plan making its interest pari passu with other investors and changing the method for calculating advisory fees.  Rather than lose the investor, the SEC alleges that it allowed the preferential rights to continue while raising money from other investors without disclosure.  The SEC also alleges that the firm lied in responses to due diligence questionnaires and falsified financial statements.   The SEC cites various violations of the anti-fraud rules, including Rule 206(4)-8 of the Advisers Act, even though the defendant was not registered.

OUR TAKE: As a fiduciary, a firm cannot offer preferential treatment to large investors.  Treating investors differently raises significant fiduciary concerns even where the firm makes clear and conspicuous disclosure.