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News December 14, 2015 Issue

Advertising Past Performance and Recommendations Draws SEC Interest

The SEC has made no secret that adviser advertising is an area it pays close attention to. The agency is always looking for advertising practices it feels may mislead investors. High on the list of such practices are how an adviser presents past performance and past recommendations.

Alpha Fiduciary, a Phoenix-based adviser, and Arthur Doglione, its majority owner and president, felt the sting of the SEC’s focus on November 30, when they settled with the agency for allegedly improper advertising practices. The SEC claimed that the firm provided prospective clients with past performance information that was misleading because it was backtested and hypothetical, and past investment recommendations that looked good, but were misleading because they were out of context. The firm and Doglione agreed to retain an independent compliance consultant, pay a $250,000 civil money penalty, and notify both existing and prospective clients of the settlement.

The firm, which as of May of this year had $737 million in assets under management, allegedly engaged in the questionable marketing practices to sell its Global Tactical Multi Asset Class Strategies (GTMACS). Alpha Fiduciary hawked the strategy as one that would "reduce portfolio volatility and enhance returns by investing in seven to 10 global, diversified assets classes," the SEC said.

"The best approach would be to avoid hypothetical performance entirely, and if you are going to use it, do so only with sophisticated investors," said Sidley Austin partner Mark Borrelli. Even then, he said, "a small amount of disclosure is not going to cut it. There should also be prominent disclosure that the performance is hypothetical on the same page that the performance appears."

"The firm fully cooperated with the SEC during this investigation," said the attorney representing Alpha Fiduciary and Doglione. "The firm has addressed many of the issues in the order, including ceasing use of the marketing material in 2013, terminating the employee referred to in the order, and hiring a CCO in early 2014. The firm fully intends to comply with all the terms in the SEC’s order."

The road there

From at least August 2010 to March 2013, the firm and Doglione created and distributed to clients and prospective clients performance results in their advertising that "failed to disclose with sufficient prominence and detail" that the GTMACS performance was "hypothetical rather than actual," the agency said. The two "created the GTMACS’ hypothetical performance by selecting a static allocation of seven to nine indices to maximize returns and minimize volatility when back-tested to 1999," before either the firm or the investment strategy existed.

In fact, the SEC said, the GTMACS model portfolios "never represented the holdings of any [Alpha Fiduciary] account, nor could they," the SEC said. "Many of the indices comprising the models had no corresponding tracking product like a mutual fund or exchange-traded fund, making replication of the back-tested holdings impossible."

In other words, said Borrelli, "it would have been impossible, in this case, to have a portfolio that actually invested in these indexes," which he said drives home the SEC’s point about the limitations of hypothetical performance.

Just how did Alpha Fiduciary and Doglione communicate these results? According to the administrative order instituting the settlement, they used charts and tables in the firm’s various marketing materials, including the firm’s website. The performance data was periodically updated to the recent quarter, with comparisons made to the performance of the S&P 500 index. As an example, the SEC noted that Alpha Fiduciary’s advertising material showed that one of its GTMACS models had a 163.34 percent return from January 1999 through September 2012, compared to a 17.20 percent return by the S&P 500 during that same period.


One of the big issues the SEC has with use of hypothetical performance data is disclosure. It went after Alpha Fiduciary here, hammer and tongs.

While the agency acknowledged that Alpha Fiduciary’s "executive summaries, firm profiles and presentations disclosed that they contained ‘certain hypothetical performance and portfolio information,’" it said that the firm "did not disclose that all of GTMACS’ performance data was completely hypothetical."

The SEC found that the disclosure of hypothetical presentations was at times buried in a document. "In [Alpha Fiduciary’s] firm profiles and presentations, the disclosure language did not appear on the same page as the hypothetical performance data, but at or near the end of a 25 or 60 page document," it said.

"Hypothetical performance needs to be clearly labeled as hypothetical each time it is presented and accompanied on the same page or in close proximity to the area the hypothetical performance is shown," said K&L Gates partner Michael Caccese. "Disclosure cannot be buried in the back of the presentation."

Emails, the SEC said, were no exception. The firm’s vice president and business development director allegedly emailed a handful of clients and prospective clients the GTMACS hypothetical performance data "without including even the disclosure about ‘certain hypothetical performance and portfolio information.’" In other emails to prospective clients, the same executive "also made misleading statements suggesting the hypothetical GTMACS’ model performance data represented actual past performance," the agency said.

It also allegedly provided prospective clients with a redacted report of an existing client’s portfolio, which the SEC said, for example, presented a 14.4 percent return net of fees over a six-month period. Alpha Fiduciary and Doglione "selected the sample client portfolio without considering whether it was representative of the performance of its other [firm] clients," the agency said.

Further, the agency said that Alpha Fiduciary went so far as to make statements in its advertising suggesting that the hypothetical performance data "represented actual returns." As an example, it noted that "[Alpha Fiduciary’s] firm profile stated that since January 1999, its Balanced GTMAC Strategy Index had produced a 6.98 percent annualized rate of return. Another presentation, the agency said, indicated that "if you would have invested with Alpha Fiduciary over the last 10 years," a $1 million investment would have increased to almost $2.4 million, a rate of return of 119.61 percent.

Past specific recommendations

The SEC also charged Alpha Fiduciary with violating Advisers Act Rule 204(6)-1(a)(2), the Past Specific Recommendations Rule. The rule prohibits advisers from including in their advertisements past investment recommendations that may have been profitable –
unless the adviser, in including the recommendations in its advertisements, meets certain conditions. One of those conditions is that any recommendation included be part of a list of all of the adviser’s investment recommendations made during the past year, a requirement that would prevent an adviser from cherry-picking only those recommendations that proved profitable.

In the Alpha Fiduciary settlement, the SEC noted that while the firm’s advertising materials included examples of investment decisions made in 2009 and 2010 that generated realized or unrealized gains of 5.51 percent to 58.62 percent, other investment decisions were not profitable. The firm "never provided, or offered to provide, a list of all its profitable and unprofitable investment decisions during that time period to prospective clients," the agency said.

"The Past Specific Recommendation Rule is alive and well and needs to be complied with," said Caccese. "Advisers cannot ignore this rule."

Violations and remedies

In addition to being charged with willfully violating the Past Specific Recommendation Rule, Alpha Fiduciary was charged by the SEC with willfully violating Section 206(2) of the Advisers Act, which prohibits advisers from engaging in fraud. It was also charged with willfully violating Section 206(4) and its Rule 206(4)-1(a)(5), which makes it illegal for an adviser to publish, circulate or distribute an advertisement containing an untrue statement of material fact.

Finally, Alpha Fiduciary was charged with willfully violating Rule 206(4)-7, the Compliance Program Rule, which requires that advisers adopt and implement written compliance policies and procedures. The SEC noted that the firm’s compliance manual required the chief compliance officer to review and approve any marketing materials or advertising prior to their being sent to clients or prospective clients.

That CCO would have been Doglione, who, in addition to being the majority owner, managing member and president of Alpha Fiduciary, served in that function until April 2014. He "exercised sole authority over [the firm’s] policies and procedures, and he was solely responsible for the review and approval of [Alpha Fiduciary’s] marketing materials prior to their distribution to clients or prospective clients," the agency said.

Doglione was charged with having willfully aided, abetted and caused his firm’s violations of Sections 206(2) and (4), and their underlying rules.

As part of the settlement, Alpha Fiduciary agreed to retain an independent compliance consultant for at least two years, to adopt and implement all of the consultant’s recommendations, and provide written certification of its compliance. Both the firm and Doglione were censured and ordered to pay a civil money penalty of $250,000.