Rulemaking by Majority Opinion on Backtested Performance

Majority Opinion of the Commission

On October 2, 2015 the Securities and Exchange Commission (“SEC”) issued an Opinion of the Commission in the matter of Raymond J. Lucia Companies, Inc. and Raymond J. Lucia, Sr regarding backtested performance of their “Buckets of Money” strategy. An Administrative Law Judge, and the Commission on appeal, found the backtested performance to be misleading because the firm used an assumed 3% inflation rate and assumed REIT returns in the backtesting that did not reflect actual historical returns.

Dissenting Opinion

SEC Commissioners Daniel Gallagher and Michael Piwowar issued a dissenting opinion which labeled the Commission’s decision as “rulemaking by majority opinion.” They stated the opinion “creates from whole cloth specific requirements for advertisements that include the word backtest”. Gallagher and Piwowar went on to write:

“Despite the lack of any statutory or regulatory definition of what constitutes a backtest, the majority opinion finds it fraudulent or deceptive practice if a backtest fails to use actual historical rates – even if the slideshow presentation specifically discloses the use of assumed rates for certain components.”

Gallagher and Piwowar emphatically stated they did not believe that the word backtest and using an assumed 3% inflation rate were misleading.

Precedent

This Opinion has established a precedent regarding calculating backtested performance and firms using such performance should review their calculation methodology and consider whether and to what extent any assumptions were included. By the issuance of the Opinion the SEC has taken a position that backtested means using actual historical rates and returns. You may disagree, as did Commissioners Gallagher and Piwowar, nonetheless any firms using assumed rates in backtests should consider revising their data to use actual returns.

CCLS can help. We consider performance advertising to be one of our “Core” competencies and our consultants have extensive experience in this area. For information on this and other related subjects, please contact us at info@corecls.com or (619) 278-0020.