Last week we discussed the Lucia matter and the parameters it added for investment advisers to consider prior to utilizing performance advertisements. Today we will discuss two more administrative proceedings involving performance advertisements and the practical implications which can be taken from these cases.
The matter of Virtus Investment Advisers revolved around one of Virtus’ sub-advisers, F-Squared Investments. F-Squared was an investment adviser that had previously been fined by the SEC for allegedly advertising false inflated performance numbers of its most successful investment strategy, AlphaSector. AlphaSector consisted of an algorithm-based sector rotation strategy which traded nine industry exchange-traded funds from the S&P 500 Index. Virtus’ assets under management which utilized this strategy grew from $191 million at the end of 2009 to 11.5 billion by 2013. Unfortunately, F-Squared allegedly falsely stated that the AlphaSector strategy had a history dating back to 2001 and that it had historically outperformed the S&P 500 Index from 2001 to 2008. The SEC found that no assets had tracked the strategy from 2001 to 2008 and its back-tested performance data was miscalculated and substantially overstated results.
Virtus included these allegedly false and misleading performance data results in its own advertisements and filings with the SEC, including a 2009 proxy filed with the SEC where Virtus stated that F-Squared had “managed investments using the AlphaSector strategy since 2001.” In addition, Virtus allegedly made its own false and misleading statements about the past performance of F-Squared’s investment strategy in its advertisements, such as statements that AlphaSector had a “live” eight-year track record. While the SEC acknowledged that F-Squared had misrepresented the performance and history of its investment strategy to Virtus, Virtus failed to verify properly those representations before relying on them and including them in its advertisements.
The Virtus matter emphasizes the importance the SEC places on the responsibility of each investment adviser to verify independently the accuracy of any performance data displayed in its advertisements, even those provided by unaffiliated third parties. Investment advisers should take care to retain the records necessary to support all performance data included in their advertisements, and should not take information provided from third parties at face value.
The SEC also instituted proceedings against Alpha Fiduciary, Inc. and its owner, Arthur T. Doglione, for distributing advertisements to prospective clients that failed to disclose sufficiently that its back-tested performance data was hypothetical rather than actual. While Alpha Fiduciary had general disclosures stating its “use of certain hypothetical performance and portfolio information,” the SEC found this language vague and contrary to other statements within its advertisements which indicated that the performance data represented actual returns. In addition, these general disclosures were often not found on the same page as the hypothetical performance data and were not made sufficiently prominent.
The Alpha Fiduciary matter emphasizes the importance of using prominent and detailed disclosures that clearly state that back-tested performance data is hypothetical, not actual. In addition, investment advisers should be sure to place such disclosures next to the back-tested performance data and on any page where the data is repeated; general disclosures intermingled throughout a brochure containing contrary statements are insufficient.
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