SEC Charges Mutual Fund Executives with Material Misrepresentation of Investment Risks

The SEC and the CFTC charged two investment advisers and their portfolio managers (collectively, the "defendants") with making material misrepresentations to investors as to worst-case losses, risk management and the risk profile of the portfolios they managed.

In Complaints filed in the U.S. District Court for the Northern District of Illinois, the SEC and CFTC alleged that the defendants misrepresented to investors regarding (i) the method they used to calculate "worst-case" daily loss estimates and (ii) the potential losses that were determined by the method. Additionally, the SEC and CFTC stated that the defendants falsely claimed:

  • to have stress-tested their portfolios against specific historical scenarios to predict worst-case daily losses;

  • that those stress tests estimated 20-40 percent worst-case daily losses for certain of the funds, when their stress testing estimated nearly 100 percent in potential loss exposure of such funds; and

  • that they maintained consistent risk levels in these funds.

The SEC and CFTC also alleged that the defendants intentionally pursued higher risk investments in order to reach their target return goals, which resulted in trading losses of over $1 billion or nearly 80 percent of the funds' value and the ultimate closure of the advisers' business.

The SEC and CFTC are seeking (i) permanent enjoinment of the defendants, (ii) remedial ancillary relief, including disgorgement of ill-gotten gains in addition to prejudgment interest and (iii) civil monetary penalties.

The investment advisers' Chief Risk Officer ("CRO") settled similar SEC and CFTC charges, consenting to (i) disgorgement of ill-gotten gains and prejudgment interest in the amount of $97,444, (ii) a civil money penalty of $150,000, (iii) a cease and desist order, and (iv) an associational bar and undertakings to not participate in certain trading activities or register with the SEC or CFTC for three years.

Commentary

This will be an interesting case to watch as it is litigated. The defendants have denied all wrongdoing and have vowed to challenge the SEC and CFTC in court. Given the defendants' willingness to fight and the relatively reasonable terms of the settlement with the investment advisers' CRO, there may be more to the story here.

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