SAN FRANCISCO (CN) – A money managing firm’s coding error contributed to its losing $39 billion over 3 years, and the subsequent cover-up left its clients “‘holding the bag,'” Guam’s retirement fund claims in a federal class action. The pension fund sued AXA Rosenberg Group, a “quant” investor whose assets have plummeted from $70 billion to $31 billion, according to the complaint.
AXA Rosenberg uses a “quantitative investment process, which attempts to generate profits by using computer algorithms to identify large numbers of stock that may be underpriced,” according to the complaint.
“Quants” were the latest, hottest thing on Wall Street before the financial meltdown. “AXA Rosenberg also managed clients’ separate accounts using its proprietary quantitative investment process,” the complaint states. “At its height, AXA Rosenberg managed over $70 billion of assets.
“Like other ‘quant funds,’ AXA Rosenberg does not share its computer algorithms with outsiders, or even its own investors. For this reason, quantitative investing is often called the ‘black box’ of investing. As The New York Times reports, when investors place assets with a quantitative investment firm, they ‘are trusting not only that the overall strategy is sound, but also that its algorithms make sense, and, furthermore, that they have been translated properly into computer code.'”
According to this 19-page complaint, that’s where AXA slipped up.
“In early 2007, while attempting to make upgrades to AXA Rosenberg’s quantitative investment model, a computer programmer improperly coded the model, causing it to understate common risks in the firm’s stock selection process. This ‘coding error’ – which effectively eliminated one of the key components in the model for managing risk – lay undetected for over two years and affected many of AXA Rosenberg’s investment strategies for nearly three years. While the error existed, AXA Rosenberg’s investments largely underperformed benchmarks, often by a significant degree.”
The claims that AXA discovered the error “no later than June 2009. Yet several of the AXA Rosenberg’s high ranking executives – including its founder and chairman, and a fellow member of the board – covered up the error. For several months, these officers and directors concealed the error from other departments in the firm, from other senior executives in the firm, (including uppermost management), and from the Board of Directors. When the full Board finally learned of the error and cover up, it launched an internal investigation that resulted in Messrs. Rosenberg and Mead being forces out of the firm, and major ownership and structural changes to the firm.
“Significantly, AXA Rosenberg’s breach of its professional and fiduciary duties-both in allowing the error to occur, and in failing to implement adequate controls, policies, and procedures to detect, correct, and properly report flaws in the firm’s investment process-was the product of a hands-off managerial style, compelled by an agreement among AXA Rosenberg’s shareholders, that dangerously left full control over the firm’s investment process in the hands of an AXA Rosenberg founder, Barr Rosenberg. Mr. Rosenberg was accorded an ‘untouchable status’ by the firm’s other owners, and he operated AXA Rosenberg’s investment process with little or no supervision.
“In the end, plaintiff and the class were left holding the bag when AXA Rosenberg’s investment process broke down and was allowed to remain operating, for nearly three years, in a defective condition, thereby causing material losses to client portfolios.”
The class claims the SEC investigated AXA and found that AXA had “‘breached their fiduciary duties to clients’ and ‘willfully violated’ several provisions of the federal securities laws.”
Though AXA agreed to pay a $25 million fine and pay its clients $217 million, the class claims “this is wholly insufficient to compensate investors for the full amount of their damages.”
Guam claims it has more than $1.6 billion held in trust for pension benefits, and hired AXA in September 2005 to manage “a portion of Guam’s investment portfolio.”
It seeks damages to be determined at a jury trial.
Named as defendants are AXA Rosenberg Group LLC, AXA Rosenberg Investment Management LLC, and Barr Rosenberg Research Center LLC.
Guam is represented by Blair Nicholas with Bernstein Litowitz of San Diego.