This case should be read by any potential client/investor enticed by a too-good-to-be-true investment pitch. It is unfortunate when legitimate investment managers have to compete for business against wrongdoers who outright lie about their performance.
As firms implement FinTech and RegTech, they cannot simply set it and forget it. Compliance, operations, and IT personnel must work together in real time to ensure that systems reflect current regulatory requirements. Technology is a great tool, but it is not the complete answer to regulatory compliance.
The SEC charged
an unregistered day trader for lying about his trading success and misappropriating
client funds. The defendant convinced clients to hire him by asserting that
that he had done very well as a day trader over several years and then promised
over 50% annualized returns. Once retained,
the trader did very poorly and siphoned client assets for personal
expenses. According to the SEC, he then
concealed his misconduct by delivering false account statements and implementing
a microcap wash sale scheme. The
defendant also faces criminal charges brought by the U.S. Attorney’s Office for
the Eastern District of New York.
Lying about your investment track record constitutes securities fraud, subjecting you to civil and criminal penalties. Do not make performance claims unless you can affirmatively support your claims with hard data.
The SEC fined and censured a now-defunct robo-adviser for disseminating misleading marketing information that purported to show outperformance versus competitors. The SEC asserts that the respondent understated the performance of competitor robo-advisers by using only publicly available information and failing to account for actual weightings. The SEC faults the firm for publishing information without the documents or data to support its performance claims. The SEC also maintains that the firm inflated its own performance by cherry-picking certain clients and time periods. The SEC faults the firm for failing to have policies and procedures requiring the review of marketing materials in part because the Chief Compliance Officer was not aware that social media posts constituted marketing materials under the Advisers Act.
We hate (HATE!) the concept of using a competitor’s name and/or information in marketing and advertising. You are inviting your competitor to prove you wrong and thereby call you out on a regulatory violation.
The BDC should be thankful it didn’t get fined. Although the SEC alleged facts suggesting that the firm should have known about the mischaracterization, an allegation that the firm intentionally juiced reported returns would have resulted in much more significant penalties.
OUR TAKE: The lesson here for fund managers is to avoid forward-looking or target performance projections. If the rosy predictions ultimately fall short, the SEC will retrospectively review all internal communications and activities for any information that might have suggested lower numbers. We recommend discussing performance through the lens of the rear-view mirror rather than the windshield.
The SEC has proposed a new rule that would allow third party broker-dealers to publish research reports about registered investment companies without having to comply with current performance presentation requirements. Proposed Rule 139b would allow a broker-dealer that is not affiliated with the fund’s adviser to publish research reports that meet certain presentation requirements even where the broker-dealer participates in the offering. A similar safe harbor already exists for other issuers. The SEC seeks comment about whether performance information should be required to comply with Rule 482’s performance presentation requirements currently applicable to fund advertising.
OUR TAKE: We would go a step further and rewrite Rule 482 to allow more flexibility for all fund materials. Then, the SEC would not have to wrestle with whether to allow different types of fund reports depending on the preparer, which could result in more confusion.
The staff of the Division of Investment Management has granted no action relief to allow a merged subsidiary to continue to use its performance track record. The SEC noted that the internal reorganization described would result in a newly-created division utilizing the same investment personnel and processes. The applicant, which merged the former separate entity into another investment adviser subsidiary, distinguished the reorganization from the Great Lakes no action letter, where the SEC came to a different conclusion because the new investment committee had personnel changes.
OUR TAKE: This letter will help investment adviser roll-ups by private equity firms and other strategic buyers by allowing internal corporate structuring freedom without fear of losing performance track records.
OUR TAKE: Investment advisers must adopt and implement procedures to test performance claims made by third parties, and firms can’t claim ignorance and innocence if the third party refuses to provide backup data. Also, we do not believe firms should ever use hypothetical backtested performance data, because the SEC usually alleges that such information is too misleading.