SEC Prevails at Trial of F-Squared Co-Founder

The Commission prevailed at trial last week, with the jury returning a verdict in its favor just hours after closing argument. SEC v. Present, Civil Action No. 1:14-cv-14692 (D. Mass. Filed Dec. 22, 2014). Defendant Howard Present was the co-founder and CEO of F-Squared Investments, Inc., a firm which had been a registered investment adviser since 2008. The firm at one time was the largest marketer of index products using exchange traded funds.

In August 2008 the adviser began creating a model portfolio of ETF’s in various sectors of the U.S. economy. One step involved the acquisition of the right to use a new quantitative algorithm that generated signals indicating when to buy or sell. The AlphaSector portfolio of ETFs was to rebalance periodically based on the signals.

F-Squared launched the index in October 2008. It was marketed as having employed a highly successful strategy since at April 2001. The results were represented to be based on actual investments rather than calculated, hypothetical results or backtesting. In fact that claims regarding the results for the strategy was not true. The results were from backtesting. In addition, the results, which showed substantial returns, were the result of a flawed process because of an inadvertent error. Mr. Present learned of the error in 2008 but took no steps to correct it. He was also the face of the advertising campaign for the new portfolio. The complaint alleged violations of Advisers Act Sections 206(1), 206(2), 206(4) and 207. The question of remedies will be considered by the court in future proceedings.

Previously, the company settled with the Commission. In the Matter of F-Squared Investments, Inc., Adm. Proc. File No. 3-16325 (Dec. 22, 2014). The Order in this case, based on essentially the same facts as the case against Mr. Present, alleged violations of Advisers Act Sections 204(a), 206(1), 206(2), 207 and Investment Company Act Section 34(b). In resolving the matter the Commission took into account the remedial efforts of the adviser which included retaining an independent consultant. The firm agreed to implement a series of undertakings. In settling the action the adviser admitted to a series of facts detailed in Appendix A to the Order which set-forth the predicate for the violations and admitted that its conduct violated the securities laws. The firm also consented to the entry of a cease and desist order based on the Sections cited in the Order and agreed to pay a $30 million fine.

The actions of F-Squared and Mr. Present also resulted an a series of enforcement actions against other advisers. Those actions were primarily based on the failure of the advisers to conduct appropriate due diligence regarding the product prior to recommending it. See, e.g., In the Matter of Virtus Investment Advisers, Inc., Adm. Proc. File No. 3-16959 (November 16, 2015)(Order alleged violations of Advisers Act Sections 204, 206(2) and 206(4) and Investment Company Act Section 34(b); resolved with retention of a compliance consultant and consent to the entry of a cease and desist order based on the Sections cited in the Order and to a censure; payment of disgorgement of $13.4 million, prejudgment interest and a civil penalty of $2 million); see also, In the Matter of Schneider Downs Wealth Management Advisers, Adm. Proc. File No. 3-17493 (August 25, 2016)( alleging adviser made misstatements to certain advisory clients, and was negligent in relying on the materially inflated, hypothetical and back-tested performance track record that F-Squared had misrepresented; alleged violations of Advisers Act Sections 204(a) and 206(4); resolved with the entry by consent to a cease and desist order based on the Sections cited in the Order, and the payment of a penalty of $100,000); In the Matter of Banyan Partners, LLC, Adm. Proc. File No. 3-17495 (August 25, 2016)(same); In the Matter of Shamrock Asset Management, LLC, Adm. Proc. File No. 3-17492 (August 25, 2016)(same); In the Matter of J.J.B. Hilliard, Adm. Proc. File No. 3-17498 (August 25, 2016)(same);In the Matter of AssetMark, Inc., Adm. Proc. File No. 3-17504 (August 25 2016)(same); In the Matter of Congress Wealth Management LLC, Adm. Proc. File No. 3-17503 (August 25, 2016); In the Matter of BB&T Securities, LLC, Adm. Proc. File No. 3-17502 (August 25, 2016); In the Matter of Constellation Wealth Advisors LLC, Adm. Proc. File No. 3-17501 (August 25, 2016); In the Matter of Executive Monetary Management, LLC, Adm. Proc. File No. 3-17499 (August 25, 2016); In the Matter of Ladenburg Thalmann Asset Management Inc., Adm. Proc. File No 3-17497 (August 25, 2016).