SEC Settles Charges Against US Hedge Fund Over Investment Model Vulnerabilities

The U.S. Securities and Exchange Commission (SEC) has reached a settlement with Two Sigma, a prominent U.S. hedge fund, over the fund's failure to address known vulnerabilities in its investment models. The settlement, announced on January 17, 2025, highlights the importance of risk management and regulatory compliance in the hedge fund industry.



Two Sigma, founded in 2001 by John Overdeck and David Siegel, is a quantitative hedge fund with approximately $60 billion in assets under management. The fund specializes in using advanced algorithms and data analysis to make investment decisions. However, the SEC's investigation revealed that Two Sigma failed to adequately address known vulnerabilities in its investment models, leading to negatively impacted client returns.

The SEC's order found that Two Sigma employees identified and recognized issues in certain models that could negatively impact clients' investment returns as early as March 2019. Despite this knowledge, the fund waited until August 2023 to address these issues. During this period, Two Sigma made investment decisions that it otherwise would not have made, leading to negatively impacted client returns.



In addition to the delayed response to the vulnerabilities, the SEC found that Two Sigma failed to adopt and implement written policies and procedures to address these issues. Furthermore, the fund failed to supervise an employee who made unauthorized changes to more than a dozen models, exacerbating the situation.

As part of the settlement, Two Sigma agreed to repay $165 million to impacted funds and accounts during the SEC's investigation. Additionally, the fund agreed to pay an additional $90 million in civil penalties to settle the charges. The SEC's order also imposed a cease-and-desist order and censure on Two Sigma.

The SEC's enforcement action against Two Sigma serves as a reminder of the importance of risk management and regulatory compliance in the hedge fund industry. Hedge funds must be vigilant in identifying and addressing potential vulnerabilities in their investment models to protect their clients' interests. Failure to do so can result in significant financial penalties and reputational damage.

In light of this settlement, hedge funds should review their risk management practices and ensure that they have adequate policies and procedures in place to address potential vulnerabilities in their investment models. Additionally, funds should ensure that they have effective supervision and oversight of their employees to prevent unauthorized changes to investment models.



The SEC's enforcement action against Two Sigma also highlights the need for increased regulatory oversight and transparency in the hedge fund industry. As the industry continues to grow and evolve, regulators must ensure that hedge funds are held accountable for their actions and that investors are protected.

In conclusion, the SEC's settlement with Two Sigma serves as a cautionary tale for hedge funds and investors alike. Hedge funds must prioritize risk management and regulatory compliance to protect their clients' interests and maintain their reputation. Investors should carefully evaluate the risk management practices of hedge funds before making investment decisions. By doing so, both hedge funds and investors can help ensure the stability and integrity of the financial system.