SEC Charges AXA Rosenberg Entities for Concealing Error in Quantitative Investment Model
Firms Agree to Pay More Than $240 Million to Settle SEC Charges
FOR IMMEDIATE RELEASE
Washington, D.C., Feb. 3, 2011 — The Securities and Exchange Commission today charged three AXA Rosenberg entities with securities fraud for concealing a significant error in the computer code of the quantitative investment model that they use to manage client assets. The error caused $217 million in investor losses.
AXA Rosenberg Group LLC (ARG), AXA Rosenberg Investment Management LLC (ARIM), and Barr Rosenberg Research Center LLC (BRRC) have agreed to settle the SEC's charges by paying $217 million to harmed clients plus a $25 million penalty, and hiring an independent consultant with expertise in quantitative investment techniques who will review disclosures and enhance the role of compliance personnel.
The SEC's order instituting administrative proceedings against the firms found that senior management at BRRC and ARG learned in June 2009 of a material error in the model's code that disabled one of the key components for managing risk. Instead of disclosing and fixing the error immediately, a senior ARG and BRRC official directed others to keep quiet about the error and declined to fix the error at that time.
"To protect trade secrets, quantitative investment managers often isolate their complex computer models from the firm's compliance and risk management functions and leave oversight to a few sophisticated programmers," said Robert Khuzami, Director of the SEC's Division of Enforcement. "The secretive structure and lack of oversight of quantitative investment models, as this case demonstrates, cannot be used to conceal errors and betray investors."
The SEC additionally charged BRRC with failing to adopt and implement compliance policies and procedures to ensure that the model would work as intended.
According to the SEC's order, ARG is the holding company of BRRC and ARIM, which are Orinda, Calif.-based investment advisers registered with the SEC. BRRC developed and maintains the computer code for the quantitative investment model and ARIM uses the model to manage client portfolios.
The SEC found that the error, which was introduced into the model in April 2007, was eventually fixed for all portfolios. However, knowledge of the error was kept from ARG's Global CEO until November 2009. ARG then conducted an internal investigation and disclosed the error to SEC examination staff in late March 2010 after being informed of an impending SEC examination of ARIM and BRRC. ARG disclosed the error to clients on April 15.
The SEC's order further found that ARG, BRRC, and ARIM made material misrepresentations and omissions about the error to ARIM's clients. The firms failed to disclose the error and its impact on client performance, attributed the model's underperformance to market volatility rather than the error, and misrepresented the model's ability to control risks. BRRC did not have reasonable compliance procedures in place to ensure that the model would assess certain risk factors as intended. The coding process for the model represented a serious compliance risk for BRRC and its clients because accurate coding is required for the model to function properly and in the manner represented to clients.
"Quant managers must be fully forthcoming about the risks of their model-driven strategies, especially when errors occur and the models don't work as predicted," said Bruce Karpati, Co-Chief of the Asset Management Unit in the SEC's Division of Enforcement.
Rosalind R. Tyson, Director of the SEC's Los Angeles Regional Office, added, "Quant managers need to ensure that their compliance policies and procedures are tailored to the risks of their model's strategies, and that compliance personnel are integrated into the development and maintenance of their investment models."
In its order, the SEC found that ARG willfully violated anti-fraud provisions of the Securities Act of 1933, Sections 17(a)(2) and (3); ARIM willfully violated an anti-fraud provision of the Investment Advisers Act of 1940, Section 206(2); and BRRC willfully violated anti-fraud and compliance provisions of the Advisers Act, Sections 206(2) and 206(4) and Rule 206(4)-7 thereunder.
Without admitting or denying the SEC's findings, ARG, ARIM and BRRC consented to the entry of an SEC order that requires them to cease and desist from committing or causing any violations and any future violations of these provisions; censures them; and orders them jointly and severally to pay the $25 million penalty. The SEC's order also requires ARG, ARIM and BRRC to comply with certain undertakings, including a payment of approximately $217 million to redress harm from the coding error to the clients of ARIM and other ARG-affiliated advisers. The undertakings also include reorganization of the firms' compliance functions and the hiring of an independent compliance consultant to conduct a comprehensive review of the firms' overall supervisory and compliance policies and procedures — specifically the disclosure, recordkeeping and reporting processes for the quantitative investment model.
In the settlement with ARG, ARIM and BRRC, the SEC considered remedial actions they undertook and cooperation they afforded SEC staff. Staff from the SEC's Asset Management Unit and regional offices in Los Angeles, San Francisco and New York contributed to this investigation. The case was investigated by Jason P. Lee and Marshall S. Sprung of the Los Angeles office. Alice L. Schulman, Arturo Hurtado, and Michael Tomars, securities compliance examiners in the San Francisco office, conducted the related examination under the supervision of branch chief Kenneth P. Schneider. Allan I. Kahn of the New York Regional Office also participated in the investigation. Sprung and Kahn are members of the Asset Management Unit. The SEC's investigation is ongoing.
The SEC acknowledges the assistance of the U.S. Department of Labor's Employee Benefits Security Administration.
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For more information about this enforcement action, contact:
Bruce Karpati (212-336-0104) and Robert Kaplan (202-551-4969)
Co-Chiefs, Asset Management Unit, SEC Division of Enforcement
Rosalind R. Tyson
Regional Director, Los Angeles Regional Office
Marshall S. Sprung
Assistant Regional Director, Asset Management Unit, Los Angeles Regional Office