The Securities and Exchange Commission settled charges against hedge fund manager Two Sigma for failing to address known vulnerabilities in its investment models.
Two Sigma agreed to pay $90 million in civil penalties to settle the SEC’s charges, according to an SEC news release Jan. 16.
The firm also voluntarily repaid impacted funds and accounts $165 million in December 2023 and January 2024.
"Two Sigma not only failed to respond reasonably to known vulnerabilities to its investment models, but also failed to adopt and implement reasonable policies and procedures governing such models," said Sanjay Wadhwa, acting director of the SEC’s division of enforcement, in the news release. "The federal securities laws require investment advisers like Two Sigma to take steps — both proactively and reactively — to minimize operational risks to protect their clients."
The SEC said that between March 2019 and October 2023 Two Sigma “recognized significant vulnerabilities to certain of its models that could materially adversely impact clients’ investment returns.”
Employees expressed concerns that changes could be made to model parameters “without review or approval and that such changes could materially impact Two Sigma’s investment decisions for its clients.” The SEC said Two Sigma “failed to reasonably address these vulnerabilities for years.”
A senior engineer at Two Sigma circulated a memorandum to executives and one of the firm’s co-founders in January 2022 about “lack of access controls for model parameters stored in CelFS and the absence of controls to ensure modelers followed an approval process for changes to these model parameters.” While no malicious incidents had occurred at that point, the memo said, “it is nevertheless dangerous to allow this, and efforts are in place to limit and eventually allow only data engineering to have write access.”
Between November 2021 and August 2023, Two Sigma failed to supervise one of its modelers, whom the SEC identified only as Modeler A. The modeler changed parameters “without approval for 14 models that Two Sigma was using in live trading.”
The SEC said the changes resulted “in certain funds and SMAs (separately managed accounts) overperforming by more than $400 million and other funds and SMAs underperforming by approximately $165 million.”
A Wall Street Journal story first identified the Two Sigma employee as Jian Wu. Wu pushed back against Two Sigma in court, but the case was later listed as disposed.
The SEC also separately found that Two Sigma violated the whistleblower protection rule by requiring departing individuals to state in their separation agreements that they had not filed a complaint with any governmental agency.
“After proactively reporting the issue in 2023 and promptly remediating negatively impacted clients, Two Sigma is pleased to have reached a resolution with the SEC, putting this matter behind us,” a Two Sigma spokesperson said in an email. “We are committed to acting with the utmost integrity and have made a range of enhancements to our operational policies, procedures, and oversight. We are focused on the future and delivering value for our clients.”
Two Sigma has about $60 billion in assets under management.
The firm has also been grappling with leadership changes. Its feuding co-founders John Overdeck and David Siegel stepped down as co-CEOs last year, and Scott Hoffman and Carter Lyons were appointed co-CEOs.
Overdeck recently filed arbitration against Siegel "related principally to the compensation of certain senior investment professionals," according to an investor letter seen by Pensions & Investments.