The SEC has settled its case with investment management firm F-Squared Investments, which has admitted wrongdoing in the case.
The SEC announced Dec. 22 that F-Squared, described in the settlement as “the largest marketer of index products using exchange-traded funds (ETFs),” has agreed to pay $35 million and admit wrongdoing to settle charges that it defrauded investors through false performance advertising about its flagship product.
The SEC separately charged the firm’s co-founder and former CEO Howard Present, as the public face of F-Squared, with making false and misleading statements to investors.
According to the SEC’s order instituting a settled administrative proceeding against F-Squared, the Massachusetts-based firm began receiving signals from a third-party data provider in September 2008 indicating when to buy or sell an investment. The signals were based on an algorithm, and F-Squared and Present used the signals to create a model portfolio of sector ETFs that could be rebalanced periodically as the signals changed. They named the new product “AlphaSector” and launched the first index a month later. AlphaSector’s indexes quickly became the firm’s largest revenue source, and, according to the SEC, F-Squared went from losing money to becoming a highly profitable investment manager.
The SEC alleges that while marketing AlphaSector into the largest active ETF strategy in the market, F-Squared falsely advertised a successful seven-year track record for the investment strategy based on the actual performance of real investments for real clients, though the SEC said that the algorithm was not even in existence during the seven years of purported performance success. Instead, the SEC said that the data used in F-Squared’s advertising was actually derived through backtesting, though F-Squared and Present specifically advertised the investment strategy as “not backtested.” Furthermore, the SEC said that the hypothetical data contained a substantial performance calculation error that inflated the results by approximately 350%.
According to a press release, F-Squared will pay a $5 million civil penalty and disgorge $30 million in profits to resolve the case. F-Squared has also agreed to retain the services of an independent compliance consultant it voluntarily hired at the beginning of 2014 for an additional nine months.
“We are pleased to put this matter behind us so that we can focus on our clients and continue to invest to ensure that our compliance, research, analytics and operational teams are best-in-class,” said Laura Dagan, Chief Executive Officer, F-Squared. “We greatly appreciate the continued support of our clients who have maintained confidence in F-Squared’s ability to deliver downside protection in down markets and upside participation in rising markets.”
Last month, F-Squared announced Dagan’s appointment as Chief Executive Officer. Dagan previously served as Chairman, and prior to that CEO, of Dwight Asset Management Company, a fixed income and stable value asset management firm.
