One of the hallmarks of a fiduciary is following through on the service you promise to deliver, acting in the best interests of your client, and providing factual information.
When that doesn’t happen, billions of dollars in assets are involved, and clients are harmed, the Securities and Exchange Commission (SEC) steps in to protect investor rights.
On January 27, 2020, the SEC announced charges against Catalyst Capital Advisors LLC (CCA), a New York-based investment adviser, for misleading investors about the management of risk in its Catalyst Hedged Futures Strategy Fund.
The SEC’s complaint cited Catalyst President and CEO Jerry Szilagyi for a lack of oversight and a failure to take corrective action when Senior Portfolio Manager Edward Walczak fraudulently misrepresented how he would manage risk for the Fund through material misstatements and omissions and breaches of fiduciary duty.
Irresponsible Marketing Content
A core selling point of the Catalyst Hedged Futures Strategy Fund as cited in its marketing materials was a risk management process devised to limit the extent of any losses. Walczak and Catalyst highlighted “aggregate portfolio stop-loss measures” designed to prevent losses of more than 8% as a distinguishing feature of the Fund in fund prospectuses, on conference calls, in due diligence questionnaires, and in wholesaler talking points to investors and advisors.
The marketing of the Fund’s risk management was a contributing factor in its rapid growth from $7 million in assets under management from September 2013 to more than $4 billion by November 2016. Walczak directly benefited from the Fund’s asset growth as his compensation was tied to the size of the Fund’s assets under management. He was paid more than $24 million in 2016 alone.
The absence of the stop-loss system promised investors became apparent between December 2016 and February 2017, when the Fund lost $700 million, or approximately 20% of its net asset value.
During this same time period, the Fund’s benchmark, the Standard & Poor’s 500 Total Return Index (“S&P 500”), increased approximately 8%. Not surprisingly, retail investors questioned Catalyst wholesalers whether Walczak had managed risk as he had promised and demanded to know what had happened to the 8% maximum drawdown figure they were told about.
One investment adviser who had allocated millions of dollars of its clients’ assets to the Fund determined that Walczak had “made a large directional bet that was inconsistent with his investment process as we understood it.” In its complaint, the SEC said it had determined that Walczak had knowingly or recklessly made or substantially participated in making misrepresentations and omissions of material fact.
Insufficient Oversight
Walczak, who was at his home in California at this time, did not send a reply to either text. The next day, Szilagyi emailed Walczak, again expressing concern about the adequacy of Walczak’s risk metrics, stating “Our shareholders just will not tolerate a 4+% drawdown on a day the market moves less than 1%. We need to consider making adjustments given the current market conditions and shareholder base. We can start with a call but I think an in-person meeting is warranted.”
Walczak did not adjust his risk metrics or meet with Szilagyi as suggested in the email, at this time or in the following weeks. Walczak traveled from his home in California to his home in Hawaii on January 30, 2016, and remained there until February 18, 2017. In the end, the SEC cited Szilagyi for a lack of oversight in his position as President and CEO.
Let our Experience Work for You
“Disclosures about what you do and how you will do it, do matter,” says Michelle L. Jacko, Esq., Managing Partner of Jacko Law Group. “The key takeaway here is to be sure your marketing materials align with what you are actually going to do…keeping in mind that material omissions will find you in violation of the anti-fraud provisions, and enforcement actions likely will soon follow.”
Jacko Law Group can help your firm in a variety of situations. Contact our team of attorneys today.