SEC Fines Investment Adviser Firm $300,000 for Failure to Prevent Cherry Picking

January 18, 2017

A former investment adviser firm and its principal recently settled claims by the U.S. Securities and Exchange Commission (SEC), admitting that the investment adviser firm principal cherry picked profitable trades for a select number of favored friends, clients, and family members of the firm’s principal.

According to the SEC, the investment adviser firm disregarded its own policies and procedures, as well as the representations in its Form ADV Part 2A, to consistently allocates profitable trades to certain favored clients. The investment adviser firm’s Form ADV Part 2A represented that the firm would seek to allocated trades in the “most equitable way possible” among its clients and would avoid treating any accounts more favorably than others. Similarly, its compliance manual and policies and procedures called for the firm to allocate trades equitably, prohibited the investment adviser firm form allocating trades in a way that would unfairly benefit the investment adviser, its principals, or favored clients, and required the investment adviser firm to conduct regular reviews to detect favoritism.

For at least four years, however, the investment adviser firm’s principal utilized a single master account to make trades each day. At the end of each day, the investment adviser firm’s principal allocated profitable trades to the accounts of favored clients. Trades that did not result in first day profits were allocated to other clients, where the investment and consequent losses became part of the client’s portfolio. During this time, the investment adviser firm ignored multiple warnings from its broker and account custodian, which had flagged its day trading allocation practices as potentially improper or suspicious.

Statistical analyses by the SEC revealed a less than 1% likelihood that the performance of the favored accounts could have occurred without the investment adviser firm actively steering profitable trades to certain accounts at the expense of others. Tellingly, the investment adviser firm’s most favored accounts were comprised nearly entirely of day trades and 90% of those day trades had resulted in a profit for the client, whereas the disfavored client accounts had fewer day trades and overwhelmingly reflected unrealized first day losses.

This SEC action highlights the importance of ensuring your investment adviser firm’s actual practices conform to the written compliance manual and Form ADV representations. In this case, despite the fact that the investment adviser firm had robust written policies and procedures regarding cherry picking and made the appropriate representations in its Form ADV Part 2A, it was easy enough for the firm’s principal to disregard the written policies for his own gain.

Whether your investment adviser firm needs help creating robust written policies and procedures or reviewing these documents in light of your actual practices, RIA Compliance Consultants can help. Contact your consultant or click here to schedule an introductory call.

Posted by Bryan Hill
Labels: Cherry Pick, Enforcement, SEC, Uncategorized