Four Transamerica affiliates were ordered by the Securities and Exchange Commission Monday to refund $97 million to misled retail investors over faulty investment models created by an inexperienced junior analyst.
According to the SEC’s order, investors put billions of dollars into mutual funds and variable annuity strategies using the faulty models developed by investment advisor Aegon USA Investment Management LLC, along with its affiliated investment advisors Transamerica Asset Management and Transamerica Financial Advisors, and its affiliated broker-dealer Transamerica Capital Inc., which claimed that investment decisions would be based on AUIM’s quantitative models.
The agency also brought separate charges against AUIM’s former global chief investment officer, Bradley Beman, and AUIM’s former director of new initiatives, Kevin Giles, for causing certain AUIM violations.
Between July 2011 and June 2015, the order states, the affiliates violated the federal securities laws while offering, selling and managing 15 quantitative-model-based mutual funds, variable life insurance investment portfolios, and variable annuity investment portfolios and separately managed account strategies.
Starting in 2010, “AUIM tasked the analyst — who had recently earned his MBA, but had no experience in portfolio management or any formal training in financial modeling — with developing quantitative models for use in managing investment strategies (i.e., models making investment allocation and models making trading decisions),” according to the order.
“AUIM ultimately used these models to manage each of the products and strategies,” the order states.
The analyst “did not follow any formal process to confirm the accuracy of his work, and AUIM failed to provide him meaningful guidance, training or oversight as he developed the models or to confirm that the models worked as intended before using them to manage client assets.”
The four affiliates marketed all of the products and strategies as “managed using a proprietary quant model,” and highlighted, when marketing certain of the products and strategies, their ‘emotionless,’ ‘model-driven’ or ‘model supported’ investment management process and described how the models were supposed to operate,” the SEC said. “These claims necessarily implied that the models worked as intended.”
However, the four affiliates launched the products and strategies “without first confirming that the models worked as intended and/or without disclosing any recognized risks associated with using the models.”
During the summer of 2013, AUIM, the order continues, “discovered that certain of the models contained errors and concluded that that these errors rendered at least one of the models ‘to not be fit for purpose.’”
AUIM stopped using, running or relying on at least one of the models in September 2013, but AUIM and Transamerica Asset Management “failed to disclose the models’ errors and AUIM’s decision to stop using the model to the board of trustees of Transamerica Funds,” according to the SEC order. “Certain of the respondents never publicly disclosed the discovery of errors or AUIM’s decision to discontinue use of the model.”
“Investors were repeatedly misled about the quantitative models being used to manage their investments, which subjected them to significant hidden risks and deprived them of the ability to make informed investment decisions,” said C. Dabney O’Riordan, co-chief of the SEC Enforcement Division’s Asset Management Unit.
A spokesperson for the Transamerica affiliates said in a statement Monday that “while the models at issue are no longer in use, we recognize we must do better, and we have taken steps to enhance our policies, procedures and disclosure processes. We remain confident in our investment process and are committed to continuously improving our business. We cooperated fully with the SEC throughout the regulatory investigation of the issues and are pleased to put this matter behind us.”
Without admitting or denying the SEC’s findings, the four Transamerica entities agreed to settle the SEC’s charges and pay nearly $53.3 million in disgorgement, $8 million in interest, and a $36.3 million penalty, and will create and administer a fair fund to distribute the entire $97.6 million to affected investors.
In separate orders, the SEC found that Beman did not take reasonable steps to make sure the mutual funds’ models worked as intended and that he and Giles both contributed to AUIM’s compliance failings related to the development and use of models.
Beman and Giles agreed to settle the SEC’s charges without admitting or denying the findings and pay, respectively, $65,000 and $25,000 in penalties that also will be distributed to affected investors.