Last month, Virtus Investment Advisers agreed to pay $16.5 million to settle with the SEC for negligently providing its fund investors with false performance data. Surprisingly, the SEC held Virtus responsible for the false performance data despite the fact that the data came from sub-advisor F-Squared Investments, and despite the fact that the SEC claimed F-Squared itself committed fraud and lied to Virtus about that performance data.

The Virtus case is the latest in a long line of cases in which the SEC seeks to hold investment advisors responsible for the statements or information of others. Some of those efforts have been more successful than others.

Holding an advisor responsible for statements “made” by the funds it advises became problematic after the Supreme Court ruled in a case called Janus Capital. In Janus, an investment advisor who drafted a prospectus for one of the funds it managed was held not liable for securities fraud in the funds’ prospectus. The Supreme Court concluded that “One who prepares or publishes a statement on behalf of another is not its maker.”

The SEC has attempted to sidestep the Janus problem by claiming that the limitation only applies in private lawsuits. That argument was quickly rejected in 2011 by one of the SEC’s own administrative law judges in proceedings stemming from investment advisor State Street Global Funds Management’s Limited Duration Bond Fund.

In that case, the SEC pursued two State Street employees for misrepresentations to investors included in a slide presentation. Specifically, the SEC claimed that one of the employees committed securities fraud because he presented to investors a slide showing a “typical” portfolio exposure to asset-backed securities of 55% when the fund fact sheet from around the same time of the presentation showed the portfolio’s actual exposure to ABS at that time was 100%.

The SEC’s ALJ found that the employees were not responsible for and did not have ultimate authority over the fact sheets and portfolio slides used with investors. However, the SEC later reversed its own ALJ, and the State Street employees appealed that reversal to a federal appellate court. 

On Dec. 9, the appellate court ruled in favor of the State Street employees, finding that they had not committed securities fraud. In finding against the SEC, the appellate court concluded that the advisor employee’s presentation of “a slide containing sector breakdowns labeled ‘typical,’” while other, more specific information was available, was not an “extreme departure from the standards of ordinary care.”

The SEC’s difficulty in holding investment advisors liable for intentional or reckless securities fraud for information and statements made or provided by others failed to stop the SEC from bringing its recent case against Virtus for information provided by its sub-adviser F-Squared. However, perhaps in recognition of the possible legal challenges, the SEC claimed that Virtus’s conduct was merely negligent rather than reckless or intentionally fraudulent.

The SEC’s action against Virtus shows why investment advisors should take no comfort from the SEC’s setbacks in court such as in the State Street matter. Undaunted by those setbacks, the SEC will modify its legal theories and shop for receptive judges in pursuit of its efforts to hold advisors responsible for information provided to investors whether the advisors created the information or “made” the statements that included the information and whether or not the advisors were reckless in or intentionally deceitful in doing so.