On August 25, 2016, the SEC announced settled administrative proceedings against thirteen investment advisory firms (the Advisers) for negligently relying on an unaffiliated adviser’s materially inflated, hypothetical and back-tested performance track record. According to the SEC orders, the matter stemmed from the misrepresentations made by F-Squared Investments, Inc. (F-Squared) regarding the performance history of its “AlphaSector” strategy, which was marketed to each of the Advisers as a sector rotation strategy for investing in ETFs.
The SEC alleges that each Adviser entered into a model manager agreement with F-Squared whereby the Adviser would establish an investment product based on the AlphaSector strategy. According to the SEC, each Adviser used advertisements repeating F-Squared’s false statements that: (1) the AlphaSector strategy had been used to manage client assets from April 2001 to September 2008; and (2) the track record had significantly outperformed the S&P 500 Index from April 2001 to September 2008. In fact, the SEC alleges, no assets tracked the strategy until 2008 and the back-tested track record was substantially overstated. (By a separate settled administrative proceeding announced by the SEC on December 22, 2014, F-Squared agreed to pay disgorgement of $30 million and a penalty of $5 million and admit wrongdoing to settle charges that it defrauded investors through false performance advertising.)
The SEC orders state that each Adviser took insufficient steps to confirm the accuracy of the AlphaSector performance data before using it in its own advertisements and did not obtain sufficient documentation to substantiate F-Squared’s advertising claims. Consequently, the SEC alleges that each of the Advisers failed to have a reasonable basis to believe that AlphaSector’s performance was accurate for use in its own advertisements for clients considering the strategy. In a statement, Andrew J. Ceresney, Director of the SEC’s Division of Enforcement, said that “[w]hen an investment adviser echoes another firm’s performance claims in its own advertisements, it must verify the information first rather than merely accept it as fact.”
Each of the Advisers consented to the entry of an order finding that it violated: (1) Section 206(4) of the Advisers Act and Rule 206(4)-1(a)(5) thereunder by publishing, circulating and distributing advertisements that contained untrue statements of material fact; and (2) Section 204(a) of the Advisers Act and Rule 204-2(a)(16) thereunder by failing to make and keep true, accurate and current records or documents necessary to form the basis for or demonstrate the calculation of the performance or rate of returns that it circulated and distributed. Without admitting or denying the findings, the Advisers agreed to pay between $100,000 to $500,000 in penalties (based upon the fees each firm earned from AlphaSector-related strategies).
A press release issued by the SEC about this enforcement matter, including a link to each of the SEC orders, is available at: https://www.sec.gov/news/pressrelease/2016-167.html