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SEC Fines Adviser for Negligence in Performance Claims

The SEC announced a settlement with Virtus Investment Advisers over allegations that it “misled mutual fund investors and others with advertisements containing false historical performance data about AlphaSector, a major exchange-traded fund (ETF) portfolio strategy.” According to the order, “AlphaSector is a sector rotation strategy based on an algorithm that yields a “signal” indicating whether to buy or sell nine industry exchange-traded funds (“ETFs”) that together made up the industries in the S&P 500 Index” and was used on six mutual funds advised by Virtus.

The charges are related to a settlement announced in December 2014 with F-Squared, a sub-adviser hired by Virtus.  According to the SEC, F-Squared presented a hypothetical back-tested track record as a true track record and further inflated the calculations “by incorrectly implementing signals in advance of when such signals actually could have occurred.” The order states that Virtus included these performance figures in the funds’ prospectuses and used them in its marketing materials despite a warning in late 2009 from FINRA that “[b]ack-tested performance is misleading.”.  The SEC also found that in May 2013, the data provider that supplied the “signals” for AlphaSector to F-Squared informed Virtus that attempts to recreate the claimed track record had failed. The order notes that wholesalers used by Virtus provided inaccurate information regarding the back-testing and that “Virtus did not take adequate steps to correct the misstatements of its sales force and wholesalers.”

The SEC found that although Virtus “expressed skepticism” and asked questions initially, it failed to follow up. Andrew Ceresney, Director of the SEC’s Enforcement Division, said that “Virtus accepted F-Squared’s historical performance misrepresentations at face value and ignored red flags that called these statements into question.” As a result, the SEC found that Virtus acted negligently.  The SEC also found that Virtus did not have adequate related policies and procedures, nor did it keep adequate records.

The order states that Virtus asked the boards of the funds (as well as the funds’ shareholders) to approve F-Squared and AlphaSector based in part on the false performance information.   According to the order, the boards were told that Alphasector had used the strategy since 2001.  The order did not allege any wrongdoing on the part of the board.

Virtus retained a compliance consultant in April 2015 to perform a “comprehensive review” of these issues. To resolve the charges, Virtus agreed to pay a total of $14.5 million in disgorgement and interest, as well as a civil penalty of $2 million.