SEC headquarters in Washington SEC headquarters in Washington. (Photo: Diego Radzinschi/ALM)

New York-based Catalyst Capital Advisors and Jerry Szilagyi, its CEO and president, agreed to pay a combined $10.5 million to settle charges by the Securities and Exchange Commission that it misled investors about the management of risk in a mutual fund, the SEC said Monday.

The SEC on Monday also filed a separate complaint in U.S. District Court for the Western District of Wisconsin, in Madison, against the firm’s senior portfolio manager, Edward Walczak, alleging he fraudulently misrepresented how he would manage risk for the same fund.

The SEC’s settled order against CCA and Szilagyi found that, although the firm told investors that it abided by a strict set of risk parameters for the Catalyst Hedged Futures Strategy Fund, it breached those parameters and failed to take the required corrective action during a majority of the trading days between December 2016 and February 2017.

The fund lost hundreds of millions of dollars — about 20% of its value — from December 2016 through February 2017 “as markets moved against it,” according to the SEC.

CCA launched the fund as an SEC-registered mutual fund in September 2013 after converting it from a private fund that Walczak established in December 2005, the SEC said in its order agreeing to the settlement, filed Monday. The fund invests mainly in options on the S&P 500 index futures contracts and is sold to investors via unaffiliated investment advisors and broker-dealers, the SEC said.

A “core selling point” of the fund was CCA’s risk management procedures, the SEC said. But it said in the order: “In promoting such procedures, CCA and the Senior Portfolio Manager made material misstatements in investor-facing marketing documents and in telephone calls with investment advisers that it utilized stop loss measures and triggers to exit positions that would limit the Fund’s losses.”

The SEC’s order found that CCA violated the antifraud provisions of federal securities laws, and that Szilagyi was a cause of CCA’s violations and failed to reasonably supervise Walczak.

Without admitting or denying the findings, CCA and Szilagyi agreed to be censured, to cease and desist from future violations, and pay disgorgement of $8.2 million, plus prejudgment interest of $731,759, and a civil penalty of $1.3 million, the SEC said. Szilagyi, meanwhile, agreed to pay a civil penalty of $300,000. The payments will be placed in a fair fund to be distributed to affected investors, the SEC said.

CCA was “pleased to have resolved this matter regarding the Hedged Futures Strategy Fund,” Szilagyi told ThinkAdvisor by email Tuesday. He added: “Catalyst is committed to best-in-class services and its award-winning funds speak for themselves. Here, as the SEC settlement recognizes, the company voluntarily retained an outside consultant in 2017 to review and evaluate its risk procedures and practices and made structural enhancements to its risk management and supervisory functions. These regulatory settlements, and a court’s dismissal of a federal class action regarding the Hedged Futures Strategy Fund in June 2019, allow the company to focus on what it does best: Offering unique investment products to meet the needs of discerning financial advisors and their clients.”

However, Szilagyi declined to comment on the SEC’s suit against Walczak. The CEO referred ThinkAdvisor to the senior portfolio manager’s lawyer, Zachary Ziliak, who didn’t immediately respond to a request for comment.

The SEC’s complaint against Walczak alleged that he violated the antifraud provisions of federal securities laws and sought a permanent injunction, disgorgement of ill-gotten gains and a civil penalty. The SEC alleged that he told investors the fund “employed a risk management strategy involving safeguards to prevent losses of more than 8%, when in fact no such safeguards limited losses and Walczak did not otherwise consistently manage the fund to an 8% loss threshold.”

The fund “ultimately lost approximately 20% of its net asset value between December 2016 and February 2017, including more than 15% in February alone,” the SEC said in the suit. The fund’s total loss of more than $700 million was “comparable to the $667 million loss forewarned by the Fund’s assistant portfolio manager,” the SEC noted.

“Fund managers must be truthful and transparent when describing their risk management procedures,” C. Dabney O’Riordan, co-chief of the SEC Enforcement Division’s Asset Management Unit, said in a statement,

Daniel Michael, Chief of the Division’s Complex Financial Instruments Unit, added, “Here, CCA’s misrepresentations, and Walczak’s alleged departure from his stated approach to managing risk, deprived investors of accurate information about an important aspect of the fund’s management.”