SEC Uses Broker-Dealer Data to Uncover Cherry-Picking Scheme
The SEC has commenced enforcement proceedings against an adviser for cherry-picking options trades. The SEC asserts that over a 3-year period, intra-day trades allocated to personal accounts returned 6.28%, but trades allocated to clients lost 5.05%. The broker that maintained the adviser’s omnibus account warned the adviser on several occasions about his allocation methodology and ultimately terminated its relationship with the adviser because of the issue. The SEC has stated that this action is the first of its kind arising from its “data driven initiative to identify potentially fraudulent trade allocations.” Julie M. Riewe, CoChief of the SEC Enforcement Division’s Asset Management Unit, indicated that the SEC discovered this cherry-picking scheme by identifying “specific custodians providing services to investment advisers and their clients and leverage their trading records and other data to efficiently target preferential trade allocations occurring outside the detection of even the most observant client.”
OUR TAKE: The SEC is leveraging market access points such as broker-dealer custodians and using data analytics to uncover fraud perpetrated by even small advisers. Firms should know that it is better to comply with the law than assume they won’t get caught.