Adviser Mis-Used Software to Create Hypothetical Backtested Performance
The SEC sanctioned an investment adviser for using software that purported to show the performance of certain models over time but actually showed hypothetical backtested performance. The SEC says that the adviser sent Morningstar’s Principia reports, which it said showed how its models performed against custom indexes. However, the adviser used the software by inputting its current models and running reports showing how the models would have performed over various historical time periods. However, the SEC alleges that some of the models were not in place during the time periods and that the reports did not show actual results of models that were used. The SEC charges that the adviser misled investors by not disclosing that the reports were actually hypothetical back-tested results. The SEC charged the adviser with violations of the anti-fraud rule and charged the firm’s principal, who also served as the Chief Compliance Officer, with violating the compliance rule (206(4)-7) because the firm did not adopt or implement policies and procedures that would prevent the distribution of misleading performance information. The adviser agreed to a $200,000 and the appointment of an independent compliance consultant.
OUR TAKE: Compliance officers should ask portfolio managers specific questions about the inputs used to generate model performance data. Just because the PM uses commercial software doesn’t mean the report is not misleading. Said another way: Garbage in, garbage out.