SEC Enforcement Action Reminds Advisers Not To Pass Along False Performance Claims

On March 22, 2018, a final judgment was entered against an investment adviser who was the former CEO of F-Squared Investments. There have been numerous enforcement actions related to F-Squared’s false and misleading performance claims, which were disseminated by other investment advisers.

The United States District Court for the District of Massachusetts imposed a $1,575,000 penalty and ordered the CEO to pay disgorgement of $10,849,604 along with prejudgment interest of $1,377,003. The District Court concluded that the CEO intentionally or recklessly violated Sections 206(1), 206(2), 206(4) and 207 of the Investment Advisers Act of 1940, as well as Rule 206(4)-8. The CEO also knowingly or recklessly aided and abetted F-Squared’s violation of Section 206(4) of the Act and Rule 206(4)-1 thereunder. The SEC instituted public administrative hearings on March 29, 2018, and its order can be found at https://www.sec.gov/litigation/admin/2018/ia-4870.pdf.

The SEC has brought several enforcement actions in conjunction with F-Squared’s inaccurate performance claims. On August 25, 2016, the SEC announced sanctions against thirteen Registered Investment Advisers (RIAs) that violated securities laws by disseminating F-Squared’s performance data. The SEC determined that these thirteen firms did not question F-Squared’s claims that its AlphaSector strategy had outperformed the S&P 500 index for a number of years. These firms forwarded F-Squared’s performance results without substantiating and verifying the returns, which were significantly overstated.

The RIAs conducted little, if any, due diligence and relied on F-Squared’s claims that these were actual returns. In fact, F-Square’s returns were back-tested, which are hypothetical and do not represent actual trading in clients’ accounts. For this reason, regulators are suspicious of RIAs that use back-tested returns in their advertisements. Back-tested results do not necessarily meet the SEC’s strict requirements related to performance advertising. Back-testing makes use of hypothetical reconstruction of historical market data to show how an account would have performed if it was managed using a specific investment strategy.

In its Risk Alert dated September 14, 2017, the SEC’s Office of Compliance Inspections and Examinations reported that its examiners frequently see advertisements containing hypothetical and back-tested performance returns. Those advertisements often failed to explain how these results were derived. In addition, the advertisements did not disclose other potentially material information relating to the advertised performance.

RIAs would be wise to heed Andrew J. Ceresney’s warning to RIAs that take performance claims at face value. Ceresney, the former director of the SEC Enforcement Division, said, “When an investment adviser echoes another firm’s performance claims in its own advertisements, it must verify the information first rather than merely accepting it as fact.”

https://www.ncsregcomp.com/team/les-abromovitz/