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Adviser Affiliates to Pay Over $97 Million In SEC Settlement for Flawed Quantitative Investment Models

On August 27, 2018, the SEC announced that it had settled an enforcement action against certain Transamerica- affiliated registered investment advisers and broker-dealers relating to the development and marketing of allegedly flawed quantitative model-based investment products and strategies. The SEC alleged that Transamerica violated various provisions of the federal securities laws by, among other things, marketing these products and strategies as “model-driven” or “model-supported” without confirming that the models worked as intended or disclosing associated risks.

According to the SEC, in 2010 one of the Transamerica affiliates tasked a junior analyst—a recent business school graduate, with no portfolio management experience or formal training in financial modeling—with developing quantitative models that Transamerica ultimately used in the management of various mutual funds, variable insurance products and SMAs. The SEC alleged that Transamerica failed to provide adequate guidance, training
or oversight to the analyst and failed to confirm that the models worked as intended before using them to manage client assets. In addition, although the analyst was the day-to-day manager of certain of the model-based products, the marketing materials for these products initially identified a senior portfolio manager as the sole portfolio manager for the products, later identifying the analyst as part of the management team. Other alleged improper activity included (1) failing to provide adequate risk disclosure regarding the use of quantitative models; (2) including undisclosed return of capital in dividend payments for certain model-based products and not having sufficient controls in place to ensure that investing in accordance with the applicable model could support a target distribution rate; (3) using volatility overlay strategies for certain products without adequately disclosing to investors or the board that these strategies could bring the products out of compliance with stated portfolio guidelines; and (4) including “materially inflated” hypothetical back-tested performance information for F-Squared Investments, Inc. in marketing materials for certain SMA strategies.

According to the SEC, the Transamerica-affiliated subadviser responsible for implementing the models identified errors in the models and ceased using them in 2013 without notifying investors, the products’ boards or the products’ affiliated adviser or distributor. The SEC further alleged that by early 2014, the adviser and distributor learned that the models contained errors and were no longer being used, but they did not disclose these facts to investors or the boards. The SEC identified the failure to inform the boards in connection with the advisory contract renewal process as a violation of Section 15(c) of the Investment Company Act of 1940.

Without admitting or denying the foregoing, in settlement of the allegations, the Transamerica affiliates agreed
to be censured, to cease and desist from violating relevant provisions of the federal securities laws and to pay approximately $97.6 million in disgorgement, civil monetary penalties and prejudgment interest. In addition, there were separate settlements reached with two individuals, the former CIO and the former product development director at one of the Transamerica affiliates, each of whom agreed to pay a monetary penalty.

The SEC order is available here.

© 2018 Vedder Price

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Vedder Price P.C. attorneys provide a full range of services to a diverse financial services clientele. Attorneys practicing in the firm’s Investment Services Group are experienced in all aspects of investment company and investment adviser securities regulations, broker-dealer regulatory and compliance matters, derivatives and financial product matters, and ERISA and tax matters. Clients include mutual fund complexes, hedge and other private funds, money managers, broker-dealers, independent directors, and many other types of institutions such as banks, savings and loans,...

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