Unlocking Real Value Blog

AK In The News: F-Squared Settles Fraudulent Advertising Charge With SEC

I was asked to comment on an article in today’s Fundfire (A Financial Times Service) about F-Squared Investment’s settlement with the SEC. The firm, a very large exchange traded fund (ETF) strategist, agreed to pay $35 million and admitted wrongdoing in the case concerning false performance advertising.

The firm advertised real performance which was in fact hypothetical back-tested data. They also made a performance calculation which inflated performance by 350%, and the former CEO has also been charged with making false and misleading statements to investors.

I was asked how this would affect the firm’s distribution. Simply, I think it will be fatal. This is not simply a case where the SEC has alleged something, which may or may not be true. The firm has admitted that it has done what it has been accused of. From a due diligence point of view, and considering fiduciary responsibility, how can a sponsor firm, who is after all making recommendations to its advisors, who is in turn making them to investors, allow this firm to remain on their platform?

Many firms put the firm on “Watch” when the allegations surfaced – the correct move – and did not allow assets to be added. But now, the only correct move is to terminate F-Squared and help clients move the assets elsewhere. The firm obviously lied in the due diligence process, so this seems like a very clear case of sponsor’s being better off moving on. I personally can not see any rationale for not terminating this relationship.

To quote from the article: “The result of the investigation, and the fact that F-Squared admitted wrongdoing, could have serious consequences for the firm’s distribution prospects, says Andrew Klausner, a strategic consultant with AK Advisory Partners.

It could be “a kiss of death in terms of distribution through broker-dealers and RIAs,” Klausner says. Since the firm admitted wrongdoing, “I don’t know how [broker-dealers and RIAs] could justify keeping them on their platform.””

The firm does have new management,and in time, they should be allowed to present their case, but I would be hard pressed if I was in charge of a sponsor’s due diligence to allow them in now. I would much rather be competing against a sponsor who continues to use the firm than to be that firm!


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