Adviser Pays $1.9 Million SEC Penalty For False Ads
Adviser advertising has been a key focus of the Commission. This is true for both OCIE and Enforcement. OCIE has issued alerts on the subject; Enforcement has filed settled enforcement actions. In many instances, the issues revolve around marketing materials which are based on back-tested results where the advisory did not specifically disclose that fact. Enforcement’s latest settled proceeding is based on precisely this claim. In the Matter of Massachusetts Financial Services Company, Adm. Proc. File No. 318704 (August 31, 2018).
Respondent has been a Commission registered adviser since 1982. The firm has about $378 billion in regulatory assets under management, including pooled investment vehicles as well as managed accounts for institutional clients.
Historically the firm, which traces its roots to 1924, has been a fundamental-based active investment manager. In 2000 the advisory established a quantitative-based research department. Blended research strategies were subsequently developed. Those involve making investment decisions using both fundamental and quantitative research ratings by combining or blending portfolios of each type together was coupled with an optimization process along with risk and other portfolio constraints to create a blended stock score. Several different blended strategies were developed.
In 2003 the firm created an analysis internally known as “research proof.” It calculated annualized returns from February 1995 — the earliest point for which the firm had stored fundamental ratings –for six hypothetical baskets of stocks. In 2006 MFS began using the research proof analysis in advertisements. The charts compared annualized returns from February 1995 through the date of publication for research proof’s hypothetical baskets. The charts showed that the hypothetical portfolios of “buy” stocks at the fundamental quant intersection performed better than either the hypothetical portfolio stocks rated “buy” by the firm’s quantitative models or the hypothetical portfolio of stocks rated “buy” by the adviser’s fundamental research. The same was true on the sell side. Stated differently, the charts illustrated the point that over time blended stock ratings provided better return potential than either fundamental or quantitative ratings alone.
The charts were used in marketing materials for institutional investors and financial intermediaries. They were also incorporated in a published white paper regarding the firm’s blended research philosophy.
The materials were false and misleading, according to the Order. The research proof chart failed to state that for the period 1995 to 2000 for all stocks, and for the period 2000 to 2003 for some stocks, the result of the retroactive application of the quantitative model were back-tested. If the adviser had relied only on actual and not back-tested quantitative ratings then the hypothetical blended portfolio of buy-rated stocks would have outperformed the hypothetical quantitative-only portfolio to a significantly smaller extent. In late 2015 the adviser removed the research proof chart from advertisements.
The adviser did not have policies and procedures designed to prevent inaccurate statements about the research proof chart. While certain firm personnel knew or understood some of the quantitative ratings were back-tested, others did not. Different groups of compliance personnel were used to review the blended research advertisements prepared for different audiences. That contributed to the advertisements describing the ratings in different terms. Accordingly, the firm failed to adopt and implement the appropriate policies and procedures.
The Order alleges violations of Advisers Act sections 206(2) and 206(4). To resolve the proceedings the firm consented to the entry of a cease and desist order based on the sections cited in the Order and to a censure. The adviser will also pay a penalty of $1.9 million.