F-Squared to Pay $35M to Settle Charges that It Misled Investors

F-Squared Investments Inc. has consented to pay $35M to settle Securities and Exchange Commission charges accusing the firm of making false claims regarding the performance of a key investment product. F-Squared admitted that it misled clients for several years about its AlphaSector strategy.

F-Squared is the largest marketer of index products that use Exchange-Traded Funds. The SEC claims that F-Squared falsely advertised that the AlphaSector investment strategy had a successful track record that was based on actual investment performance for real clients when, in fact, the algorithm touted didn’t even exist during the noted time period.

The algorithm was the basis of signals sent from a third party data provider indicating when to sell or buy an investment. F-Squared and Howard Present, its co-founder and ex-CEO, used the signals to develop the AlphaSector, a model portfolio of sector ETFs that could be rebalanced from time to time when the signals changed. After its launch in 2008, AlphaSector’s indexes became the company’s largest revenue source.

However, the data from the supposed track record didn’t come from actual investment performances but from backtesting, which generates a hypothetical performance during a past period. However, the strategy was marketed as “not backtested.” Also, the information included a substantial performance calculation mistake that created a 350% inflation of the results. The SEC says that the ETF presented that AlphaSector was the strategy to manage assets beginning in April 2001.

The analyst who calculated the strategy’s performance made a mistake by applying sell and buy signals to the week prior to the price changes upon which the signals were based. This allowed for an ETF to be purchased right before the price increased and sold right before it dropped. Even after the analyst attempted to explain the mistake to Present in 2008, F-Squared kept advertising the false information for five years.

InvestmentNews reports that since the disclosure of the false advertising and the beginning of the SEC probe, Wells Fargo Advisors (WFC) and other brokerages have raised warning flags to their advisers about F-Squared.

The SEC filed separate civil charges against Present for making misleading and false statements to investors. He was accountable for the ETF strategist’s advertising materials. Present also was responsible for AlphaSector descriptions in SEC filings, as well as for verifying their accuracy. The agency says Present was aware of the inaccuracies of statements made in the marketing of AlphaSector.

Securities Fraud

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F-Squared pays $35 million to settle claims it misled investors, InvestmentNews, December 22, 2014

The SEC Order Against F-Squared (PDF)

The SEC Order Against Present (PDF)

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