SEC Rejects ''Buckets of Money'' Appeal
Commentary by Steven Lofchie
The SEC rejected an appeal by a former registered investment adviser firm and its owner regarding charges of securities fraud violations of Investment Advisers Act Sections 206(1), 206(2) and 206(4) ("Prohibited Transactions by Investment Advisers"). The charges were based on alleged material misrepresentations made to prospective clients concerning the adviser's "Buckets of Money" retirement wealth management strategy.
The SEC found that the accused firm misrepresented that it had performed backtests that "proved" that a model portfolio following the "Buckets of Money" strategy during difficult historical market periods would substantially increase in value while also providing annual retirement income. The SEC further decided that the statements about the backtests were misleading because the firm did not inform clients that the backtests: (i) used assumed inflation and Real Estate Investment Trust rates that did not reflect historical rates; (ii) did not deduct advisory fees; and (iii) did not actually follow the "Buckets of Money" strategy by "rebucketizing" (i.e., reallocating assets between "buckets" of portfolio assets). The SEC also found that the accused firm did not inform prospective clients that actual backtests would have shown their model portfolio exhausting their assets before the end of the backtest periods, rather than substantially increasing in value.
SEC Commissioners Daniel M. Gallagher and Michael S. Piwowar dissented. They argued that the majority unnecessarily "create[d] from whole cloth specific requirements for advertisements that include the word 'backtest' [that 'must use historical inflation rates'] . . . despite the lack of any statutory or regulatory definition of what constitutes a 'backtest.'"
The dissenting Commissioners also noted that the defendants "raised important issues" as to whether the ALJ overseeing the proceeding was appointed in a manner consistent with the "appointments" clause of the Constitution. The Commissioners did not agree or disagree with the opinion's views on this point, but stated their belief that the judiciary should ultimately resolve the issue.
Commentary
There is a significant problem with using cases such as this one to "make law." The accused, whom everyone concerned agrees were guilty of fraud, are not presently in a legal position to argue the fine points of precisely how fraudulent their statements were, or what the rules ought to be going forward. Understandably, their main concern is with the level of sanction to be imposed against them.
Undoubtedly, the Commissioners would agree that the use of backtesting presentations for purposes of marketing is potentially useful, but also one fraught with the potential to mislead investors. Accordingly, the dissenting Commissioners make a good point in arguing that the permissible use of backtesting presentations should be a topic that is directly addressed by the SEC, rather than one resolved by a "holding" in a case against obvious fraudsters. Just the fact that the advisers called their strategy "Buckets of Money" should have been sufficient to send them away.