Photograph by Mike Stone — Reuters
By Stephen Gandel
December 22, 2014

The success of one of the hottest investment companies in the past few years was indeed too good to be true.

On Monday, the Securities and Exchange Commission charged F-Squared Investments and its founder Howard Present with defrauding investors into thinking the firm’s performance history was based on an actual trading record and that it had widely outperformed the S&P 500 from April 2001 to October 2008. In fact, the investment record was never based on an actual investment history; the track record was fabricated by Present and an analyst in the summer of 2008. F-Squared didn’t start advising clients until February 2009.

F-Squared settled the charges with the SEC and admitted wrongdoing. It will pay the SEC a fine of $35 million. Present, who could not be reached for comment, is fighting the charges.

In a statement, the SEC said that not only did F-Squared lie about the fact that its returns were merely hypothetical, but it also inflated its putative performance.

Fortune recently investigated F-Squared and the allegations against the firm.

“We are pleased to put this matter behind us so that we can focus on our clients and continue to invest to ensure that our compliance, research, analytics and operational teams are best-in-class,” said F-Squared CEO Laura Dagan in a statement.

F-Squared is the most successful of a number of firms that call themselves tactical ETF managers. These companies advise clients on when to buy and sell ETFs, generally based on sophisticated computer models. Nearly $100 billion has flowed into such firms since the financial crisis. F-Squared is the largest of the lot, attracting over $28 billion.

According to the SEC, Present, a former top mutual fund executive, launched F-Squared in 2006. Two years later, the firm had just $189 in revenue and over $600,000 in losses. That summer, in 2008, according to the SEC, Present negotiated a deal to license an investment strategy from a wealth advisor. The strategy had been developed by the wealth advisor’s 20-year-old intern. Present and an F-Squared analyst used the data from the wealth advisor to build a track record for the strategy going back to 2001.

In the fall of 2008, F-Squared began to market this strategy to potential clients. But instead of openly stating that the strategy’s potential performance had been calculated in 2008, Present said F-Squared’s track record was based on actual investment history. A press release from the firm said that $100 million in client assets had been devoted to the strategy since 2001. In fact, the actual amount was zero.

What’s more, according to the SEC, shortly after Present started touting his strategy, the analyst who had helped create the track record informed Present that they had made a mistake in their calculations. They had developed the model’s hypothetical performance by applying buy and sell recommendations a week before the model would have actually made those suggestions, enabling the model to buy an ETF just before the price rose and sell just before it dropped. Because of the error, F-Squared’s calculations showed that the strategy had returned 135% during the period. In fact, the strategy’s hypothetical performance should have been 38%. The SEC alleges that Present never investigated the error.

F-Squared’s marketing materials would regularly say that its performance was based on a live track record, and “not backtested.” In 2013, when the SEC approached F-Squared about its marketing claims, the SEC says, Present sent investigators figures to back up the claim that the firm’s track record was real. Those figures turned out to be false.

Present left F-Squared in November. He was paid $8 million during his time as CEO of the company, and he received an $8 million severance payment.

“Investors must be able to trust that performance advertisements are accurate,” said Andrew Ceresney, director of the SEC’s Division of Enforcement. “F-Squared has admitted that it misled its clients over a number of years about the existence and success of its core strategy.”

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