Tag: Cherry Picking

CCO Liable in Cherry Picking Scheme

According to SEC’s complaint against Strong Investment Management and its owner, Joseph Bronson, for more than four years, Bronson traded securities in Strong’s omnibus account but delayed allocating the securities to specific client accounts until he had observed the securities’ performance over the course of the day. This allowed Bronson to harvest substantial profits at his clients’ expense by “cherry picking” the trades. He would disproportionately allocate profitable trades to himself and unprofitable trades to Strong’s clients.

Of course, there is an additional charge of Strong and Bronson misrepresenting their trading and allocation practices in the firm’s Form ADV filings. The forms stated that all trades would be allocated in accordance with pre-trade allocation statements and that the firm did not favor any account, including those of the firm’s personnel. That does make me wonder if you could get away with cherry picking by stating that you could do so in Form ADV. But let’s not go down that path.

Bronson’s brother and the former chief compliance officer of Strong, John Engebretson, was also charged with failing to perform his compliance responsibilities and ignoring numerous “red flags” raised during the course of the fraudulent scheme. As a result, Engebretson was charged along with Bronson and Strong with violating the compliance requirements of the federal securities laws. Engebretson agreed to settle the charges against him. As part of the settlement, Engebretson agreed to be enjoined, pay a civil monetary penalty in the amount of $15,000, and to be barred from association with any broker, dealer, investment adviser, municipal securities dealer, municipal advisor, transfer agent, or nationally recognized statistical rating organization.

The SEC complaint alleges that as the chief compliance officer, John Engebretson aided and abetted the company’s violations by “carrying out his compliance responsibilities in an extremely reckless manner.”

The SEC Commissioners and senior Division of Examination staff have usually stated three circumstances that lead to CCO liability:

  1. when the CCO is affirmatively involved in misconduct;
  2. when the CCO engages in efforts to obstruct or mislead the Commission; or
  3. when the CCO exhibits “a wholesale failure to carry out his or her responsibilities”

I wish this standard was carried over to the Division of Enforcement. Instead, the enforcement attorneys state this

“Engebretson also aided and abetted [Strong]’s failure to implement compliance policies and procedures in several ways”

It doesn’t say that the CCO was affirmatively involved in misconduct. It doesn’t say that there was a “wholesale failure.” Please just stick with the standard. Say that “Engebretson exhibited a wholesale failure to carry out his or her responsibilities” in the complaint. Is that so hard? We can infer that the failure was wholesale. Later in the complaint, it uses “wholly abdicated his responsibilities.” So close.

Final judgement came out against Strong and Bronson recently and made me realize I never caught this story in 2018.

Sources:

Use of Data in Proving Fraud

The Securities and Exchange Commission’s case against Robert Magee and Valor Capital was a straight forward cherry picking case. What caught my eye was the data and statistical analysis that the SEC used to prove its charges.

Magee was doing the wrong thing by order block trades in an omnibus trading account and then allocating the trades to his personal account and client accounts at the end of the day. That procedure is ripe for compliance failure without a preset decision on who gets the trades. The concern will always be that the securities that increased during the day will be allocated to favored accounts and those that went down would be allocated to others.

The SEC ran the numbers to prove its point.

From July 2012 to January 2015, Magee’s personal accounts posted first-day profits of 0.876%. Those were 459 trades of which 376 were profitable on the first day.

Meanwhile, the client accounts posted a -2.309% return on the first day during roughly the same period. Those were 1,365 trades of which only 219 were profitable on the first day.

Of course, the disparate results could be based on good luck. The SEC ran some stats and found that the probability that disproportionate allocation of favorable trades was due to chance was less than one in 100,000 during one period and less than one in a trillion during another period.

Valor’s brokerage firm terminated its relationship because it suspected the cherry-picking. The subsequent brokerage firm did the same. The third brokerage firm did not permit the use of an omnibus account to execute trades. The Texas state securities regulator reprimanded and fined Magee in August 2016 for no pre-allocating block trades.

According to the SEC’s press release, this is the fourth action arising out of an enforcement initiative to combat cherry-picking led by the SEC’s Los Angeles Regional Office and supported by the agency’s Division of Economic and Risk Analysis.  The previous actions were against Jeremy Licht of JL Capital Management, Gary Howart of Howarth Financial, and Joseph B. Bronson of Strong Investment Management.

Sources:

Picking Cherries

cherry picking

As an investment adviser, you can’t take the best investments for yourself and leave the lesser ones for your clients. That’s exactly what the Securities and Exchange Commission is accusing J.S. Oliver Capital and Ian O. Mausner of doing.

The SEC’s Enforcement Division is alleging that J.S. Oliver and Mausner engaged in a cherry-picking scheme that awarded more profitable trades to favored clients. Meanwhile they doled out less profitable trades to other clients, including a widow and a charitable foundation. (You have to love the SEC’s highlighting a widow and a charity as victims. If only the charity were for orphans, then the cliche would be perfect.)

Mausner financially benefited from the cherry-picking scheme because he and his family were personally invested in the hedge funds. Plus, he earned additional fees from one of the hedge funds based on the boost in its performance as a result of the cherry-picking. Mausner profited by more than $200,000 in fees earned from one of the hedge funds based on the boost in its performance from the winning trades he allocated.

This cherry-picking scheme is the classic failure to allocate trades before they are made. Mausner made block trades in omnibus accounts at various broker-dealers. The block trades were reported to J.S. Oliver’s prime broker and then Mausner allocated the shares among the client accounts. According to the SEC complaint Mausner often delayed allocating trades until after the close of trading or the following day, allowing him to determine which securities had appreciated or declined in value.

Even if Mausner was trying to allocate trades on a fair and equitable basis, the mere fact that trades were not allocated until after they made makes the process suspect. Then you have the uphill battle of proving you were fair, when in hindsight better trades ended up in favored accounts.

Sources:

Cherry Picking Trades

compliance and cherry picking

A recent SEC action shows you exactly how to NOT allocate trades. The SEC brought charges against Howard Berger for not allocating trades until the end of the trading day.

Berger would routinely allocate the profitable trades to his wife’s account and the unprofitable trades to his private investment fund account. Since Berger would usually sell his positions at the end of the day, it was easy to see which trades worked and which ones lost money.

One trading platform seemed to be agnostic about allocations. When that trading platform went of business he switched to a second that better tracked the changes in allocations. That trading platform’s activity logs showed hundreds of instances where Berger switched allocations from the fund’s account to his wife’s account.

That’s a combination of theft and stupidity. he was blatantly stealing his client’s money and not bothering to notice the trail of breadcrumbs showing the theft.

Sources: