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First Circuit Ruling Gives SEC Victory in Long Fought Case

Earlier this month, the United States Court of Appeals for the First Circuit issued a unanimous decision upholding a circuit court’s ruling in SEC v. Navellier & Associates, Inc.[i] This ruling granted the SEC summary judgment finding that Navellier & Associates, a Nevada based investment adviser, violated Section 206 of the Adviser’s Act.

For the past ten years, we have written about a series of SEC enforcement actions centered around the advertisement of performance returns tied to F-Squared, previously the U.S. largest marketer of ETF-based index products. The F-Squared and related cases not only established the SEC’s position regarding the publication of performance advertising but also recognized an investment adviser’s fiduciary duty when adopting statements made by third parties in advertisements. The SEC’s positions were codified under the new Marketing Rule adopted in 2021.

In the F-Squared related cases, twenty investment advisers settled cases with the SEC. These cases generally found that the advisers knew or should have known that the performance claims purported by F-Squared were not accurate. Navellier & Associates refused to settle similar claims with the SEC. Subsequently, a Massachusetts District Court granted the SEC’s motion for summary judgment, finding that Navellier violated Sections 206(1) and 206(2) of the Adviser’s Act, and ordered $44 million in disgorgement penalties.

In the case before the First Circuit, Navellier argued that the failure to disclose whether performance data was backtested or were results actually achieved was not material to an investor’s decision whether to invest or not.[ii] Both the District Court and First Circuit disagreed, finding that the information was material to the perceived risk of the investment and influential to investors.

Navellier further argued that summary judgment was improper for the allegations under Section 206(1), claiming that the SEC failed to establish the necessary scienter requirement.[iii] Again, both the District Court and First Circuit disagreed. The Courts established the recklessness of Navellier, dating back to 2009 when the then-CCO of Navellier visited F-Squared to conduct due diligence.[iv] It was then that Navellier was first alerted that F-Squared could not verify years’ worth of performance data underlying its products. Ignoring the red flags, Navellier started advertising the performance returns of F-Squared. Navellier continued to advertise the returns even when the Navellier team internally questioned the activity and results of F-Squared. The discussions of the Navellier team were exhibited in a series of problematic emails reviewed by the Courts.[v] The emails not only questioned the accuracy of the F-Squared returns but also questioned whether F-Squared was itself a fraud.

When weighing the reckless nature of Navellier’s conduct, the First Circuit also took into consideration Navellier’s history regarding performance advertising and the SEC’s previous warnings. Navellier was examined in 1999, 2003, and 2007. In all examinations, the SEC issued findings that Navellier’s performance advertising failed to adequately disclose whether the results were backtested or were results actually achieved.[vi]

Navellier challenged whether the District Court’s order of disgorgement was proper under the belief that no client suffered financial harm. The First Circuit held that disgorgement is tied to unjust enrichment, and it is not necessary that clients suffer financial harm.[vii]

The First Circuit’s decision in Navellier supports the SEC’s position that the advertisement of performance results is rife with problems and is not suitable for all audiences due to the potentially nuanced nature of the information. Not all investors understand or have the capacity to understand hypothetical calculations. Even if performance advertisement is appropriate for the intended audience, what information is disclosed along with the performance results is material to the potential investors. The First Court’s decision reinforces the SEC’s long held position that advertisement of performance data requires layered and detailed disclosure to prevent information from being misleading. Such position has since been codified in the SEC’s New Marketing Rule. Investment advisers that continue to advertise performance results should adopt a robust compliance program to review the content and use of the advertisements. Advisers that fail to meet the high hurdle imposed by the SEC will continue to face regulatory scrutiny and significant penalties.

Parker MacIntyre provides legal and compliance services to investment advisers, broker-dealers, registered representatives, hedge funds, and issuers of securities, among others. Our Investment Adviser Group assists financial service providers with complex issues that arise in the course of their business, including complying with federal and state laws and rules. Please visit our Investment Adviser Practice Group page for more information.

[i] See SEC v. Navellier & Associates, Inc., No. 20-1581 (1st Cir. 2024).

[ii] See id.

[iii] See id.

[iv] See SEC v. Navellier & Assocs., No. 17-cv-11633, 2020 U.S. Dist. LEXIS 25154 (D. Mass. Feb. 13, 2020).

[v] See Navellier & Associates, Inc., No. 20-1581.

[vi] See id.

[vii] See id.

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