F-Squared pays $35 million to settle claims it misled investors

Regulators also charge former CEO for repeating claims even after performance miscalculations were reported

Dec 22, 2014 @ 11:32 am

By Trevor Hunnicutt

F-Squared Investments Inc., the largest U.S. ETF strategist, agreed Monday to pay $35 million to settle SEC charges it made false claims about the performance of its flagship investment product.

“Investors must be able to trust that performance advertisements are accurate,” said Andrew Ceresney, who leads the Securities and Exchange Commission's civil enforcement division, in a news release. “F-Squared has admitted that it misled its clients over a number of years about the existence and success of its core strategy.”

The agency had charged F-Squared with touting a seven-year track record in its AlphaSector strategy that was not based on strategies connected to real money, as well as with using faulty calculations to inflate results. F-Squared reported $25 billion in ETF-managed-portfolio assets as of September, according to Morningstar Inc.

AlphaSector grew to become one of the most popular tactical ETF strategies with portfolio managers, who used the funds as building blocks and often promoted them to advisers as mitigating the risks of a stock market rout after the 2008 financial crisis.

Despite the settlement, the SEC set the table for a public battle against the firm's co-founder and former chief executive, Howard B. Present. Unable to reach an agreement with him, the SEC filed a lengthy complaint against Mr. Present in a Boston federal court Monday. Regulators said he was F-Squared's "public face" when the firm falsely advertised its performance and had vouched for the accuracy of its filings with regulators.

“Not only did F-Squared and [Mr.] Present attract clients to this investment strategy by touting a track record they presented as real when it was merely hypothetical, but the hypothetical calculations also were substantially inflated,” said Julie M. Riewe, a unit chief within the SEC's enforcement division, in the release.

Mr. Present, a former Putnam Investments executive, stepped down as chief executive last month. A lawyer for him, Samuel Winer of Foley & Lardner, was not immediately available for comment.

On Monday, Laura Dagan, appeared in a video on F-Squared's website and said the firm now has a “culture of compliance.

“We're dedicated to operating with the highest level of integrity and have evolved substantially since 2008, when F-Squared was a six-person startup,” Ms. Dagan said.

F-Squared, which also manages a suite of five mutual funds for Virtus Investment Partners Inc., agreed to retain for an additional nine months a compliance consultant hired earlier this year. Virtus (VRTS) shares rose 1.57% in afternoon trading Monday.

Charges or a settlement were widely expected after the money manager disclosed to clients in August that it had received notice from the SEC that charges were likely. It has already admitted the track record was overstated.

The SEC said F-Squared represented the investment strategy as one used to manage assets from April 2001, when the algorithm used to make trading decisions actually was not finalized until 2008. The numbers used were hypothetical, or “back tested.” And the analyst responsible for calculating the performance mistakenly applied buy and sell signals to the week before the price changes on which the signals were based, “enabling the model to buy an ETF just before the price rose and sell an ETF just before the price fell," the SEC said.

The SEC said that after the analyst “tried to explain” the error to Mr. Present in 2008, F-Squared continued to advertise the false data for five years, representing the strategy's significant outperformance of the S&P 500 index from April 2001 to Sept. 2008.

Some clients, which include advisers across the country, were shaken by the disclosures. Brokerages, including Wells Fargo Advisors, have sent up warning flags to advisers about F-Squared since the SEC inquiry began. Others, such as RBC Wealth Management and Raymond James Financial Inc., have required advisers to rein in client exposures to F-Squared, InvestmentNews has reported.

The SEC said it is continuing its investigation.

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