F-Squared Misled Investors in ETF-Linked Strategy, SEC Says

(Bloomberg) — F-Squared Investments Inc. agreed to pay $35 million over U.S. regulatory claims that it misled investors about the performance of a trading strategy used by exchange- traded funds.

The firm admitted that performance data used to market the strategy to mutual funds and other clients was based on historical models for a seven-year period before the product existed, the Securities and Exchange Commission said in a statement today. Investors were told that the performance represented actual results from 2001 through 2008, the SEC said.

Investigators also found that the hypothetical data contained an error that further inflated the performance results by about 350 percent, the SEC said. F-Squared is the largest active-ETF strategist with about $28.5 billion invested under its index strategies, according to the agency.

Investors must be able to trust that performance advertisements are accurate, said Andrew Ceresney, director of the SECs enforcement division. F-Squared has admitted that it misled its clients over a number of years about the existence and success of its core strategy.

In a statement, F-Squared said the strategy, known as AlphaSector, has performed as expected since it was launched in 2008 and clients have seen the results in their returns. Following the strategy told investors when to buy or sell nine ETFs, the SEC said.

Downside Protection

We greatly appreciate the continued support of our clients who have maintained confidence in F-Squareds ability to deliver downside protection in down markets and upside participation in rising markets, Chief Executive Officer Laura Dagan said in the statement.

F-Squared explicitly advertised AlphaSectors performance as not back-tested, the SEC said. An F-Squared analyst tried to inform former CEO Howard Present about a mistake in the performance model in 2008. The formula continued to be used for the next five years, according to the agency.

The SEC also sued Present, alleging that he made false statements when he claimed AlphaSector was based on a strategy that had been used to invest client assets since 2001. In a statement, Presents attorneys said they would challenge the allegations, which they called misdirected and meritless.

There is no allegation in the SECs complaint that investors lost money, Brendan Sullivan and David Zinn, Washington-based attorneys at Williams & Connolly LLP, said in a statement. There is no allegation questioning the companys investment performance over the past six years.