Hedge fund managers (particularly early-stage managers) that lack a robust track record to demonstrate their investment prowess may use hypothetical backtested performance results to show how their investment strategies would have performed on an historical basis. However, the SEC and investors
strictly scrutinize the use of hypothetical backtested performance results by hedge fund managers because such results do not represent actual performance data. The concern is that hypothetical results may reflect rosy assumptions as opposed to real results, and potential investors may not be sufficiently apprised of the difference. In an expression of such concern, the SEC recently entered into a consent order with an investment adviser and its principal to settle an enforcement action in connection with the misleading use of hypothetical backtested performance results. The results at issue purported to show how the performance of the manager’s investment portfolios would have compared to designated benchmarks. This article summarizes the factual background, legal violations and settlement terms in this case. The article also describes prior SEC enforcement actions that were based on other impermissible practices in connection with the use of hypothetical backtested performance results. For another example of an SEC action premised on the use of misleading performance advertising, see “SEC Charges Hedge Fund Manager and Its Founder with Securities and Investment Adviser Fraud Based on ‘Cherry Picking’ of Trades
,” Hedge Fund Law Report, Vol. 6, No. 1 (Jan. 3, 2013).