On November 15, 2024, the U.S. District Court for the Western District of Wisconsin entered a final judgment against a former mutual fund portfolio manager (PM) for negligent misrepresentations to fund investors regarding the fund’s risk management.  Separate lawsuits were filed by the SEC and the CFTC against the PM, which were consolidated for trial. On April 18, 2022, a jury found the PM liable for negligence-based securities and commodities fraud, but not for any claims requiring proof of scienter (i.e., that the PM’s actions were done knowingly or recklessly).  The court ordered the PM to pay the SEC and the CFTC an aggregate amount of approximately $11.2 million, consisting of approximately $7.7 million in disgorgement, $1.8 million in prejudgment interest and a $1.6 million civil penalty, and enjoined the PM from managing or advising on investments in securities or commodity futures for any third parties, except for certain family members, until April 18, 2027.

According to the order, the mutual fund managed by the PM was intended to provide a hedge against a downturn in the S&P 500 Index, while still allowing for a positive return in a slowly rising market, through the use of futures options. The order states that, in weekly “house calls” with investment advisers and investors in the fund, the PM had represented, among other things, that the fund was actively managed to prevent losses greater than 8% of the fund’s assets and that daily stress testing was performed as part of the risk management process.  Further, the PM had stated that when the stress testing indicated a risk of greater than 8% losses, the PM would reposition the portfolio to ensure that an 8% drawdown would be the “worst-case scenario.”  The order states that despite the fund facing potential losses greater than 8% in 2016 and early 2017, as indicated by the stress testing, the PM failed to take steps to limit the risk of losses to 8%.  According to the order, when the S&P 500 Index rose by 2.5% within a single week in early February 2017, the fund’s value declined by approximately 17%, and when 98% of the fund’s options came due in February and March 2017, the fund lost more than $700 million, approximately 20% of its value at the time.

The jury found that the PM’s failure to manage the fund to limit downside risk to 8% by daily stress testing violated anti-fraud provisions of the federal securities laws, specifically Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933, Sections 206(2) and 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-8 thereunder, and Section 4o(1)(B) of the Commodity Exchange Act.  None of the foregoing violations require proof of scienter and, as noted above, the jury did not find the PM liable for violating other sections of the applicable securities and commodities laws that require proof of scienter.

The court’s order is available here, and a related SEC press release is available here.