SEC Charges Investment Firm and Its Manager for Engaging in Cherry-Picking Scheme (with Lofchie Comment)

The SEC announced fraud charges against an investment advisory firm and its owner for engaging in a "cherry-picking" scheme.

The SEC alleged that the investment manager purchased options in an omnibus account, or master account, and delayed the allocation of the purchases to either his or his clients' accounts until later in the day after he saw whether or not the securities appreciated in value.

According to the SEC, this action is the first arising from its effort to utilize data to identify potentially fraudulent trade allocations known as "cherry-picking." SEC Division of Enforcement staff worked with economists in the SEC Division of Economic and Risk Analysis to analyze large volumes of investment advisers' trade allocation data and identify instances in which it appeared that an adviser disproportionately allocated profitable trades to favored accounts.

Lofchie Comment: This is a nice example of the use of technology by the SEC to catch an investment manager committing fraud that could not have been caught by clients. One notable aspect of the enforcement actions is the apparent awareness of the adviser's executing broker of the adviser's misconduct. In that regard, the enforcement action reports (at page 4), "[i]n September 2012, the broker flagged Mr. Welhouse's trade allocation a ninth and final time. In December 2012, the broker terminated its relationship with [the adviser]." This makes one wonder if (i) the broker gave the adviser a few too many chances to behave correctly and (ii) the broker itself should not have reported the misconduct to the SEC, since it had reason to believe that the adviser was committing fraud against retail investors.

See: SEC Order.