An investment adviser that published and implemented an ETF sector rotation strategy agreed to pay $35 Million in disgorgement and fines and admit wrongdoing for advertising misleading backtested hypothetical performance data. The SEC also commenced proceedings against the firm’s CEO who it charges was responsible for the misleading advertising. The firm continued to use incorrect backtested performance data for its strategy even after it had reason to believe that the algorithm employed incorrectly inflated performance. Moreover, the firm failed to obtain backup data to support the performance claims after several requests from a third party data provider. The firm advertised that the backtested strategy would have nearly doubled the performance of the S&P 500 index over a 7-year historical period, but the SEC claims that the strategy would have only slightly out-performed the S&P 500 index had the firm properly conducted the backtesting. The SEC charges violations of the anti-fraud rules, the advertising rule, and the compliance rule.
OUR TAKE: Don’t use hypothetical backtested performance data. It is virtually impossible to prove to the SEC that any material outperformance is supported by adequate data.