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SEC denies Freedom of Information request by RIABiz related to Virtus funds as Ameriprise and TD Ameritrade become latest biggies to cut ties

The regulator's non-response isn't proof of an investigation but big broker-dealers continue to see smoke as fire -- and Virtus's own SEC docs seem to warn of potential trouble brewing

Monday, March 30, 2015 – 5:19 PM by Sanders Wommack
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Jonathan Haray: The real question is if the evidence will stem to Virtus from F-Squared, and in some sense the investigators are starting from scratch.

Brooke’s Note: The closer Sanders Wommack looks at Virtus Investment Partners, the more he finds. In this case, maybe even one of his non-findings is a finding. It turns out the Freedom of Information Act is no weapon against the vault doors of the SEC. But we wonder why the SEC would no-comment when it could simply say that no investigation is afoot — and why it took the agency nearly two months to no-comment based on a “general policy.” Ameriprise and TD Ameritrade are also mum but their actions, it seems, speak volumes.

A request by RIABiz asking for documents related to an ongoing SEC investigation into Virtus Investment Partners under the Freedom of Information Act was declined earlier this month, raising the possibility that the Securities and Exchange Commission is indeed examining wrongdoing at the Hartford, Conn.-based mutual fund company.

In its response to the Jan. 27 request, the SEC cited the “law enforcement exemption” clause of the act. See: AP: U.S. set new records for censoring files, denying FOIA requests in 2014

“It is the general policy of the Commission to conduct its investigations on a non-public basis. Thus, subject to the provisions of FOIA, the Commission does not disclose the existence or non-existence of an investigation or information gathered unless made a matter of public record in proceedings brought before the Commission or in the courts. Accordingly, the assertion of this exemption should not be construed as an indication by the Commission or its staff that any violations of law have occurred with respect to any person, entity, or security,” the SEC e-mailed.

Such a denial in response to a FOIA query could mean that any investigation was resolved without regulatory action or that the company was incidentally mentioned in another ongoing investigation. John Gavin, owner of FOIA-fishing website Probes Reporter LLC, writes on his website that such a denial may also have been issued in error. Official confirmation of an ongoing probe into any company can only come when the SEC’s general counsel upholds an appeal of the initial denial.

'From scratch’

“The real question is if the evidence will stem to Virtus from F-Squared, and in some sense the investigators are starting from scratch,” says Jonathan Haray, partner at DLA Piper in Washington and former assistant chief litigation counsel for the SEC.

Yet many prominent firms are not waiting around for official SEC results in order to take action.

TD Ameritrade, the custodian and broker/dealer, stopped doing business this month with F-Squared Investments and those Virtus mutual funds sub-advised by F-Squared, according to sources. A spokesman for the TD Ameritrade Institutional, Joseph Giannone, confirmed the decision to stop making these products available but declined to elaborate saying, “It would be inappropriate for us to comment any further.” See: How Howard Present parlayed an intern’s algorithm into a small fortune — and when the SEC says he knew of a mega-disconnect.

The extent of the prior relationship between the two firms is not clear. Giannone declined to comment when asked if TD Ameritrade had a custodial relationship with either F-Squared or Virtus Investment Partners. F-Squared portfolios had previously been offered on TD Ameritrade’s unified managed account platform and had provided access to its mutual funds through it’s broker-dealer. The online profile of every AlphaSector fund on TD Ameritrade’s website now includes the note, “Not Available through TD Ameritrade.”

As of today, Ameriprise Financial also prohibited its advisors from making purchases of AlphaSector products, including the Virtus mutual funds. The Minneapolis-based broker-dealer is forcing its advisors to sell those AlphaSector funds that their clients currently own.

According to documents filed with the SEC, the loss of Ameriprise patronage could be enormous; Ameriprise advisors hold at least a billion dollars in AlphaSector funds as of March 17.

Updated disclosures

Virtus Investment Partners has been under scrutiny since September 2014 when the Wall Street Journal reported that one of its sub-advisors, F-Squared Investments of Wellesley, Mass., received notice from the SEC that it expected to bring regulatory action against the firm. Since then, Virtus stock has dropped 40%, class actions have been filed against the company, and new revelations have surfaced that suggest Virtus knew much more about F-Squared’s deceit than it let on. See: How Howard Present parlayed an intern’s algorithm into a small fortune — and when the SEC says he knew of a mega-disconnect

In February, RIABiz wrote that senior officers at Virtus Investment Partners gave every appearance of knowing that the historic investment returns of F-Squared, its star sub-advisor, were based on backtesting even though Virtus marketed these returns as the real “live” returns to advisors and clients. Senior management made this admission to Virtus wholesalers during a conference in Boca Raton, Fla. in 2012, according to claims by wholesalers in attendance, but the company didn’t change the way it marketed the F-Squared AlphaSector funds until October 2013, well after the SEC began investigating F-Squared. See: Where Virtus stands after F-Squared seemingly led it astray, to mutual benefit

To date, Virtus has not disclosed to the public that it is under investigation, although it did beef up its catalog of disclosed risks when the company filed its annual report with the SEC earlier this month. Among other new entries warning about the risks of cyber-attacks and shrinking margins, the company added a section titled, “Civil litigation and government investigations or proceedings could adversely affect our business.”

Beneath that headline, the company writes that “we and/or our funds are also involved from time to time in governmental and self-regulatory organization investigations and proceedings.” the Virtus statement further read: “Predicting the outcome of such matters is inherently difficult, particularly where claims are brought on behalf of various classes of claimants or by a large number of claimants, when claimants seek substantial or unspecified damages or when investigations or legal proceedings are at an early stage.”

No assurance

The disclosure continues:

“Allegations of improper conduct by private litigants, including investors in our funds, or regulators, whether the ultimate outcome is favorable or unfavorable to us, as well as negative publicity and press speculation about us, our investment activities or the asset management industry in general, whether or not valid, may harm our reputation, which may be more damaging to our business than to other types of businesses. We may incur substantial legal expenses in defending against proceedings commenced by a client, regulatory authority or other private litigant. Substantial legal liability levied on us could cause significant reputational harm and have an adverse impact on our results of operations and financial condition.”

Elsewhere in the filing, Virtus denies that it faces any material damages from F-Squared fallout writing under its “Legal Proceedings” section that, “The Company believes, based on its current knowledge, that the outcomes of its legal and regulatory proceedings are not likely, either individually or in the aggregate, to have a material adverse effect on its consolidated financial condition.”

This statement is hedged, however, by what is written immediately before and after these lines: four sentences on how the company accrues for a liability from legal or regulatory action (previously absent from Virtus filings) and the assertion that Virtus “can provide no assurance” that its rosy assessment of its situation is correct.

TD and Ameriprise cut ties

While the investigatory process has or has not been grinding away behind the scenes at Virtus, more insidious reputational fallout is occurring in broad daylight. Fidelity Investments “ended its relationship” with F-Squared in November 2014, according to a spokesman for the firm. He further said Virtus funds are still available for purchase on its platform, but declined to elaborate on the full nature of his firm’s full relationship with the Wellesley, Mass. ETF portfolio manager. Schwab declined to comment for this article.

TD Ameritrade and Ameriprise are the highest-profile firms in months confirmed to limit their relationships with Virtus and F-Squared. Firms previously reported to have limited access to F-Squared products include RBC Wealth Management, Stifel Nicolaus, Raymond James and AssetMark. While not prohibiting new money, Wells Fargo Wealth Management warned its advisors about conducting business with F-Squared. To date, AssetMark Inc., a Concord, Calif.-based TAMP, is the only other firm that forced its advisors to transition client assets out of F-Squared products. See: Big brokers take action on F-Squared funds and Virtus shares reel as SEC actions sink in

Class action

Virtus is also facing pressure from law firms that are rounding up clients in a class-action against the company. On Feb. 20, Zamansky LLC filed Tom Cummins, et al. v. Virtus Investment Partners, a class action in the U.S. District Court of Southern New York alleging that the company and its officers concealed its knowledge and role in the F-Squared fraud.

“Virtus is liable to its shareholders because it knew that its business growth, revenue growth and profits were based upon a fraud,” Zamansky argues.

In its most recent filing with the SEC, Virtus wrote that it believes the class-action lawsuit “is without merit” and said it “intends to defend it vigorously.”

Voting with dollars

Outflows at F-Squared sub-advised funds have been enormous since the beginning of the year. Outflows and poor performance brought assets in F-Squared sub-advised mutual funds to under $6.8 billion Friday, down from about $12.5 billion in September 2014. AlphaSector funds have consistently averaged outflows of $250 million a week over the past two months.

Virtus has conceded multiple times that the fund’s poor performance is partially to blame. Year-to-date performance of the Virtus Premium AlphaSector fund, the largest of the F-Squared sub-advised funds, ranks in the 99th percentile of large-blend funds according to Morningstar, a consequence of having loaded up on cash earlier in the year as the market continued to rise. The AlphaSector funds are even performing poorly when compared against conservative benchmarks. The Allocator Premium AlphaSector fund is in Morningstar’s “moderate risk” category, but its lineup of A, C, and I shares still rank between the 91st and 93rd percentiles.

Not to blame

TD Ameritrade’s decision to distance itself and its clients from F-Squared comes days after F-Squared’s principle leader denied he was to blame for its regulatory problems. On Monday, former F-Squared chief executive Howard Present filed a response to SEC charges claiming that he didn’t know that F-Squared’s indexes were based on backtesting, and that he reasonably relied on advice from those around him. See: In reply to SEC, Howard Present blames bad advice for any alleged wrongdoing

Present also denied SEC claims that he was warned twice by people who helped to create the AlphaSector indexes that they had been seriously miscalculated and had produced wildly inflated investment histories.

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Mentioned in this article:

TD Ameritrade
Asset Custodian
Top Executive: Tom Nally



March 31, 2015 — 8:46 PM

Wow. The majority of us don’t understand that there is a treasure of information hidden in those disclosures.

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