The Securities and Exchange Commission (SEC) fined firm F-Squared Investments $35 million while admitting wrongdoing to settle charges that it defrauded investors through false performance advertising about its flagship product. As we previously reported, shares of mutual fund provider Virtus Investment Partners Inc. (Virtus Investment) tanked on news that the SEC was close to recommending charges against F-Squared a sub-adviser on the Virtus funds. F-Squared –builds mutual fund portfolios consisting of exchange traded funds (ETFs) for the Virtus mutual funds.
According to the SEC’s order, F-Squared, the largest marketer of index products using ETFs, the firm began receiving signals from a third-party data provider in September 2008 indicating when to buy or sell an investment. The SEC alleged that the signals were based on an algorithm and F-Squared used the signals to create a model portfolio of sector ETFs that could be rebalanced periodically as the signals changed. The new product “AlphaSector” launched the first index shortly thereafter. AlphaSector’s indexes became the firm’s largest revenue source.
The SEC alleged that the marketing of AlphaSector into the largest active ETF strategy in the market was based upon false information concerning F-Squared’s successful seven-year track record. According to the information provided, the marketing materials were supposed to be based on the actual performance of real investments for real clients. But in reality, the SEC found that the algorithm was not in existence during the seven years of the advertised performance success. Instead, the SEC found that F-Squared’s advertising was actually derived through backtesting to historical market data generating a hypothetical performance during a prior period.
However, F-Squared specifically advertised the investment strategy as “not backtested.” Not only was the advertising false in this respect but the hypothetical data contained a substantial performance calculation error that inflated the results by approximately 350 percent. Moreover, the SEC alleged there was a cover up of the inflated data error in that the F-Squared analyst who calculated the backtested AlphaSector performance tried to explain the possible calculation error in late September 2008. Despite knowing of a potential issue with the advertising data, F-Squared went on to advertise the inflated data for the next five years and overstated that AlphaSector significantly outperformed the S&P 500 from April 2001 to September 2008.
The five Virtus Funds are the Premium AlphaSector (VAPAX), Allocator Premium AlphaSector (VAAAX), AlphaSector Rotation (PWBAX), Global Premium AlphaSector (VGPAX), Dynamic AlphaSector (EMNAX). Investment firms have an obligation to perform due diligence and only invest their customers in investments that are suitable for that customer’s risk tolerance, age, investment objectives, and any other information disclosed by the investor.
Investors who have suffered losses in investments such as the Virtus Funds may be able recover their losses through arbitration. The attorneys at Gana Weinstein LLP are experienced in representing investors and determining when brokerage firms fail to supervise their representatives sale of unsuitable investments or their failure to perform proper due diligence. Our consultations are free of charge and the firm is only compensated if you recover.