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Asset Manager Fined $1.9 Million over Hypothetical Back-Tested Performance

 

 

The SEC fined a large asset manager $1.9 Million for failing to fully disclose that it used hypothetical back-tested performance data in advertisements.  The SEC asserts that the respondent claimed that it could prove back to 1995 that its stock strategy combining fundamental and quantitative research outperformed either approach alone.  Although the firm labeled such research as “hypothetical,” the SEC faults the firm for failing to disclose that its research was based on back-tested quantitative ratings for a time period before it generated its own quantitative models or research.  Using the longer period helped boost the claimed outperformance.  The outperformance data was used in marketing to institutional investors, RFP responses, and a white paper.  The SEC also criticizes the compliance program because compliance personnel that reviewed the materials were not informed that the materials included back-tested data.

OUR TAKE: Do not market hypothetical, backtested performance.  No amount of disclosure can ever insulate you from the SEC’s retrospective criticisms and analysis that you cherry-picked time periods or data.  Also, compli-pros should note that marketing materials delivered solely to institutional investors are subject to the same rules as more widely-distributed marketing materials (with a few exceptions such as allowing presentation of gross performance together with net performance).

Three Firms Fined for Marketing Hypothetical Third Party Performance

The SEC censured and fined three more investment advisers in connection with marketing F-Squared’s misleading hypothetical performance information.  One of the firms agreed to pay $8.75 Million in disgorgement, fines, interest and another agreed to pay over $700,000, while the third firm, which has ceased its business, agreed to pay a $200,000 fine.  The SEC alleges that the firms incorporated misleading F-Squared-provided performance information into their marketing materials without conducting adequate due diligence into the performance claims, despite significant red flags such as hypothetical backtested performance, outlier returns, lack of actual performance history, and lack of data transparency. The SEC charged the firms with failing to implement adequate compliance policies and procedures to verify third party performance claims and maintain required records.  The defunct firm, which also sponsored a registered mutual fund, was also charged with several Investment Company Act violations including violations of Section 15, which requires a shareholder-approved written agreement with all sub-advisers.  The SEC has previously brought several cases related to incorporating misleading F-Squared performance.

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.