Investment Firm Violates SEC Guidelines By Failing To Diversify


SEC ExpertThis case involves a dispute regarding the management of employee 401(k) profit sharing retirement plans. An investment advisory firm was tasked with managing investments and overseeing the fund. Allegedly, the investment advisory firm failed to diversify the investments of the fund and minimize the risk of large losses. The firm invested in a particular stock and at one point, the stock accounted for 38% of the fund’s portfolio, breaching SEC guidelines which stipulate that a mutual fund cannot invest more than 25% of its assets in a single industry without disclosing the strategy to investors in the fund’s prospectus. The stock dropped from a high of approximately $482 per share to $36 per share, subsequently, the fund’s position in the stock fell from a high of approximately $465 million to approximately $31 million, allowing the fund to suffer a loss of several hundred million. An expert in securities economics was sought to assess the loss incurred by employees from the fund’s investments and calculate additional losses in profit had the fund divested from the stock when it exceeded SEC mutual fund investment guideline and invested in other stocks.

Question(s) For Expert Witness

  • 1. When is it appropriate for a fund to divest from stocks to minimize large losses?
  • 2. How might you calculate the loss incurred by participants and beneficiaries of the retirement plan?

Expert Witness Response E-095358

In order to determine when the fund should have divested from stocks to minimize large losses, I would consider what the disclosure was to shareholders. I have spent over 4 years on a recent project calculating losses to shareholders of over 15 401(k) funds with assets under management of over a billion dollars. In this case, I created a but-for portfolio based on proper disclosure and calculated losses relative to this portfolio. I have reviewed a similar case and am serving as a retained expert on a case in which $97.6 million is set to be paid to settle SEC charges that the defendant sold investments based on quantitative models that did not work. In that case, the defendant claimed that they used spreadsheets with formulas that would assess when to invest and divest from certain stocks. We discovered that the spreadsheets were not working properly and had broken formulas. In order to asses the losses incurred by shareholders had the defendant divested and invested elsewhere, I recreated their spreadsheets, fixed the model, and compared the returns from the model we created to the model they used previously.

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