SEC Settles Investment Model Deficiency Case with Two Sigma

Last month, the SEC settled charges against two affiliated hedge fund managers for breach of their fiduciary duties and numerous compliance and supervisory failures due to weaknesses associated with the firms’ investment models. Given the increasing use of investment models across all types of funds, registered fund directors may wish to be mindful of vulnerabilities that could be associated with their use.

In its order, the SEC noted that adviser employees had identified material weaknesses in the firms’ investment models whereby certain employees could alter parameters to the models without approval.  The advisers failed to address these deficiencies despite the escalation of the issue by certain employees who proposed solutions to the problem. In addition, the advisers did not adopt or implement any written policies or procedures to address the deficiencies.  Adviser employees altered the parameters of the investment models without permission, which resulted in altered performance by the models and investment decisions that the advisers would not otherwise have made. The advisers voluntarily repaid the negatively impacted funds and agreed to other undertakings with the SEC.

Directors of registered funds that utilize investment models may wish to periodically inquire about the parameters of the models and the methodology and frequency of their testing, monitoring and oversight.  In addition, directors may wish to review any pertinent policies and procedures related to investment model utilization by funds.

Click here to view the SEC’s Two Sigma settlement press release.