Barr M. Rosenberg agreed to settle the charges and will pay the SEC $2.5 million for purposely hiding major errors in the computer code of Axa Rosenberg LLC’s quantitative investment model.The SEC’s lawsuit says that Rosenberg detected the errors in 2009, but kept them quiet, and instructed other members at his company to do the same.
Investors in the fund lost $217 million because of the error in his algo.
The material error in the model’s computer code disabled one of its key components for managing risk and affected the model’s ability to perform as expected. Clients raised concerns about this underperformance, and Rosenberg knew about and discussed these concerns with others at AXA Rosenberg…
“Investors in quant funds trust their advisers to develop, maintain and operate the quant models that drive a fund’s performance. Rosenberg betrayed investors when he failed to disclose the material coding error,” said Bruce Karpati, Co-Chief of the Asset Management Unit in the SEC’s Division of Enforcement.
The court was able to prove that Rosenberg was in charge of the model, and, as a consultant to others using the program, was considered an industry expert.
Here’s how his model worked, according to the SEC filing:
The Model consisted of three components: the Alpha Model, Risk Model, and Optimizer. The Alpha Model evaluates public companies based on their earnings and valuation. The Risk Model identifies risk on two primary bases – specific stock risk and common factor risks. Common factor risks include, among other things: (i) specific industry risks, which are risks associated with certain industries (such as oil, automobiles, or airlines); (ii) country risks, which are risks associated with particular countries; and (iii) stock fundamental risks, which capture price to earnings ratios and similar metrics. The Optimizer takes the output from the Alpha and Risk Models, balances them against each other, and recommends an optimal portfolio for the client based on a benchmark chosen by the client, such as the S&P 500.
Then in 2007, Rosenberg commissioned a new model of the risk model. Computer programmers finished designing the program in 2009, and noticed that it was spitting out weird (“unexpected”) results.
Some Risk Model components sent information to the Optimizer in decimals while other components reported information in percentages; therefore the Optimizer had to convert the decimal information to
percentages in order to effectively consider all the information on an equal footing. Because proper scaling did not occur, certain decimal information was not converted to percentages and the Optimizer did not give the intended weight to common factor risks.
Despite investors’ concerns, Rosenberg said nothing. According to the SEC:
Due to Rosenberg’s misconduct, AXA Rosenberg and its affiliated investment advisers misrepresented to clients that the model’s underperformance was attributable to factors other than the error, and inaccurately stated that the model was controlling risk correctly. Rosenberg’s instructions to delay fixing the error caused additional client losses.
Later that year, Axa’s Investment Committee authorised some, but not all, of the changes needed to fix the problem for U.S. investors. Rosenberg knew that more had to be done, but he kept quiet. The entire magnitude of the problem was not fully disclosed until March of 2010, when SEC investigators visited Axa.
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