SEC Announces Penalties Against 13 Firms Advertising False Performance Claims

August 29, 2016

On August 25th, the U.S. Securities and Exchange Commission (“SEC”) announced penalties against 13 firms for allegedly perpetuating the false performance claims of a third-party investment management firm.

The SEC found that the 13 investment advisers had each accepted the third-party firm’s returns as presented without conducting proper due diligence of their own to determine accuracy. However, according to the SEC, the firm’s returns, which were based on back-tested performance, were inflated. The 13 firms allegedly republished the firm’s false returns and used them to recommend the third-party firm to their own clients.

Amounts paid to settle the SEC’s charges ranged from $100,000 to $500,000.

These enforcement actions are a result of a recent SEC sweep that has roots dating back to December 2014, when the third-party investment management firm was penalized $35 million for allegedly producing false performance and defrauding investors. In November 2015, another investment adviser (in addition to the 13 firms now settling) agreed to pay $16.5 million for allegedly misleading investors by negligently relying on, and accepting as fact, the performance provided by that same third-party investment management firm.

On August 25, the SEC also adopted amendments to the Investment Advisers Act of 1940 books and records rule, Rule 204-2. Whereas investment advisers previously were required to maintain supporting documentation for performance calculations distributed to “ten or more persons,” the amendment now requires supporting documentation when reporting to “any person.” Additionally, advisers must also maintain original copies of any written communications received and copies of all original communications sent by an adviser that contain the performance of managed accounts or any securities recommendations. The changes to the books and records rule apply to communications circulated or distributed after October 1, 2017. The full rule release can be found here.

The use of subadvisers or a third party is common practice, but any time an adviser relies on the performance of a subadviser, appropriate due diligence should be conducted on the subadviser’s performance to substantiate the accuracy of the information. In addition, it is the adviser’s responsibility to meet all advertising requirements, including maintaining books and records to support all performance presented.

The SEC has stated that it will continue to investigate and pursue similar enforcement actions against other investment advisers that may negligently market false performance claims.

In light of this news, ACA Performance Services recommends that firms conduct a detailed review of:

  • the firm’s controls environment around the use of any performance provided by a subadviser or other third party;
  • the firm’s calculation methodologies and procedures to review any subadviser/third-party performance; and
  • disclosures accompanying any subadviser/third-party performance to ensure that they adequately convey the performance presented.

In addition, firms should confirm that they have adequate books and records to support any subadviser/third-party performance so that the firm could recreate the performance history if requested.

How ACA Can Help
ACA Performance Services offers Focused Performance Reviews to assist firms in validating investment performance and the supporting books and records. The Focused Performance Review includes a review of the appropriateness of the calculation methodologies underlying investment performance, the adequacy of controls around the creation and review of investment performance, and the completeness of accompanying disclosures. The Focused Performance Review helps firms prepare for regulatory scrutiny by strengthening the tools used to demonstrate global capabilities across strategies and the controls in place to govern how performance is produced.

For More Information
If you have questions about the SEC’s recent performance-related enforcement cases, or would like more information on our Focused Performance Reviews, please contact:

Charlie Stout, CAIA, CIPM
Partner
(866) 279-0750
cstout@acacompliancegroup.com