Wells Fargo faces major test of broker liability for selling F-Squared

Investor claims Wells Fargo did insufficient due-diligence on the troubled money manager

Jun 17, 2015 @ 12:49 pm

By Trevor Hunnicutt

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A Wells Fargo Advisors client has asked arbitrators to recover money he says he lost investing with F-Squared Investments Inc., his lawyer said Wednesday, testing whether investors can challenge brokerage firms who sold the troubled asset manager's products.

F-Squared agreed in December to pay $35 million to settle charges it made false claims about the performance of its flagship investment product. Now, an investor is demanding at least $100,000 in damages from Wells Fargo in a claim filed on Monday, according to his Chicago lawyer, D. Daxton White.

The client, a 68-year-old widower, claims Wells Fargo failed to supervise his adviser properly and didn't do enough due diligence on the investments he recommended, which included an F-Squared product, according to Mr. White.

If the case is successful, it will be the first major legal repercussion for a broker-dealer whose advisers sold F-Squared products. Wells Fargo first made F-Squared managed accounts available to its corps of 15,000 advisers in mid 2013. A Wells Fargo spokeswoman, Rachelle Rowe, declined to comment.

“The first question would be, from a compliance perspective, who approved this,” said Philip M. Aidikoff, a lawyer who represents investors and is not affiliated with this case. “A due-diligence procedure with a manager from a firm like Wells Fargo has to be very complete, very extensive, and they have to get under the hood and see whether the numbers that have been presented to them and to the customers are accurate. You can't say these guys smell good from 50 yards.”

According to Mr. White, The client, whose name is not public and is being withheld by request of his lawyer, said he started working with a Wells Fargo financial adviser in Greenville, S.C., in 2011. He said he presented himself as a moderately conservative investor seeking moderately conservative growth for the assets in his retirement account.

The adviser placed approximately $900,000 of the investor's savings, which his lawyer said was the vast majority, in products managed by two so-called ETF strategists. More than half went into an F-Squared's AlphaSector Allocator Select, and the remainder went into Good Harbor Financial's U.S. Tactical Core product.

The claim said that Wells Fargo earned about $19,000 in fees for recommending the products, eroding potential capital gains. According to a copy of the claim reviewed by InvestmentNews that created "a conflict in recommending such high commission investments.”

F-Squared routinely promoted seven years of pre-2008 results for its AlphaSector strategy, despite launching the product that year. The results were hypothetical and miscalculated and made them look more favorable.

The firm reported the discrepancies to clients and adjusted its marketing materials after the SEC launched an investigation in 2013. The track record of products it actually manages have not been called into question.

The claim argues that, had Wells Fargo conducted full due diligence on F-Squared, they would have discovered that the firm's performance track record did not align with its strategy and the strategy was not tied to actual money during the full period it claimed.

The investor earned a slight loss on the F-Squared product, 0.08%, and an 8.13% loss on the Good Harbor investment. In all, he lost $33,000, but could have earned $185,000 had he put his money in an S&P 500 index fund, according to his claim.

F-Squared's claim that its rules-based strategy could sidestep violent market swings — by opportunistically trading in and out of nine industrial-sector ETFs — appealed to advisers stung by the 2008 free-fall of stock markets. The firm built itself from a virtual nonentity in 2008 to the force behind a $28.5 billion strategy, as of last June.

Those assets have fallen significantly: The firm saw nearly $8 billion in asset declines in its ETF strategies in the year that ended on Mar. 31, Morningstar Inc. said. The mutual fund distributor Virtus Investment Partners Inc. also cut F-Squared as a manager on five of its products with some $5.7 billion in assets, including Virtus Premium AlphaSector (VAPAX). The firm cut a quarter of its workforce in March, and is said to be exploring a sale.

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