F-Squared Investments has agreed to pay $35 million and admit wrongdoing to settle charges that it defrauded investors through false performance advertising about its flagship product, according to a Dec. 22 SEC announcement.
The SEC has also charged, separately, the firm's co-founder and former CEO Howard Present with making false and misleading statements to investors as the public face of F-Squared.
"We allege that not only did F-Squared and 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 Riewe, co-chief of the SEC's Enforcement Division's Asset Management Unit, in a statement.
F-Squared, which the SEC calls "the largest marketer of index products using exchange-traded funds (ETFs)", began receiving signals based on an algorithm from a third-party data provider in September 2008 indicating when to buy or sell an investment, according to the SEC's order.
Using these signals, the Massachusetts-based investment management firm and Present created a model portfolio of sector ETFs that could be rebalanced periodically as the signals changed. The resulting new product, AlphaSector, launched its first index a month later.
The SEC alleges that while marketing AlphaSector into the largest active ETF strategy in the market, F-Squared falsely advertised a successful seven-year track record for the investment strategy based on the actual performance of real investments for real clients.
The SEC alleges that F-Squared and Present claimed AlphaSector was based on an investment strategy that had been used to invest client assets since April 2001, while in reality, the algorithm was not in existence during the seven years of purported performance success. Rather, the data in F-Squared's advertising was actually derived through backtesting – though F-Squared and Present specifically advertised the investment strategy as "not backtested." The SEC also alleges that this hypothetical data used in AlphaSector's advertising contained a substantial performance calculation error that inflated the results by approximately 350%.
"Investors must be able to trust that performance advertisements are accurate," said Andrew Ceresney, Director of the SEC's Division of Enforcement. "F-Squared has admitted that it misled its clients over a number of years about the existence and success of its core strategy."
