Adviser Settles False Performance Claims With SEC
The SEC filed a settled action involving a registered investment adviser that made false statements in marketing materials about a strategy utilized by a sub-adviser. The adviser failed to evaluate statements in the materials and ignored red flags. In the Matter of Virtus Investment Advisers, Inc., Adm. Proc. File No. 3-16959 (November 16, 2015.
Respondent Virtus has been a registered investment adviser since 1969. F-Squared had been a registered investment adviser since March 2009. That same year Virtus and F-Squared began talks to have F-Squared serve as a sub-adviser for two Virtus-advised mutual funds. Those funds would then adopt the AlphaSector strategy originated by F-Squared.
F-Squared launched its first AlphaSector index in late 2008. That strategy is an ETF sector rotation strategy that was based on an algorithm which yields a signal indicating whether to buy or sell nine industry ETFs. F-Squared claimed that the strategy had a successful “live” track record dating back to 2001. In fact no assets tracked the strategy until 2008. The back-tested track record was substantially overstated. The Commission brought a settled enforcement action in which F-Squared admitted the facts (here).
Virtus was negligent in not knowing that the F-Squared track record and performance was false. From the outset Virtus expressed skepticism about the claimed track record. Nevertheless, it took no steps to verify it. Rather, the adviser recommended F-Squared and its strategy to the boards of the two mutual funds. The claims regarding the track record for the strategy were repeated in materials presented to the board, investors and those used by wholesalers.
In late 2009 FINRA raised concerns with Virtus regarding the track record for the AlphaSector Rotation Index that was included in mutual fund marketing materials. The regulator told Virtus that the track record was based on back-testing. Nevertheless, the incorrect claims were used in marketing materials.
Two years later market participants told certain Virtus wholesalers that the AlphaSecotr indexes were back-tested and “live” assets had not been tracking those indexes since 2001. Virtus also received conflicting representations from Howard Present, the founder and CEO of F-Squared, about the origins of the strategy. While he was asked to address those concerns, no answers were furnished and Virtus failed to follow-up. Similarly, in May 2013 principals from the firm that provided F-Squared with the signals for AlphaSector told Virtus they thought the track record may have been miscalculated. There was no follow-up.
Virtus did not have any written policies and procedures for evaluating and monitoring the accuracy of third-party-produced performance information or marketing materials. The firm also failed to maintain sufficient records to demonstrate the calculation of the performance or rate of return of the historical performance of the AlphaSector indexes.
The Order alleges violations of Advisers Act Sections 204, 206(2) and 206(4) and Investment Company Act Section 34(b). To resolve the proceedings Respondent agreed to implement certain undertakings, including the retention of a compliance consultant. The firm also consented to the entry of a cease and desist order based on the Sections cited in the Order and to a censure. It will pay disgorgement of $13.4 million, prejudgment interest and a civil penalty of $2 million.