Weak Compliance Costs Firm who Failed to Stop Employee’s Cherry-Picking
The SEC fined and censured a large investment adviser for failing to implement adequate compliance polices that could have prevented a managing director from cherry-picking trades for his own benefit. The MD had exclusive access to an omnibus account at the firm’s prime broker through which he allocated trades after the close of the trading day. According to the SEC, the MD allocated 99% of profitable trades to his own account. The SEC faults the firm for failing to adopt or implement adequate policies and procedures or supervisory controls. Ultimately, the prime broker discovered the cherry-picking scheme and terminated the block trading account. As part of the remedy, the SEC has required the adviser to pay client remediation based on first-day returns of less than .25%, the blended return earned on all of the accounts including the personal allocations.
OUR TAKE: Although the firm did not benefit from its employee’s misconduct, it suffers the regulatory consequences for failing to implement an adequate compliance and supervisory program to stop a bad actor. Firms without a compliance infrastructure have no defense against regulatory accusations involving rogue employees. Separately, it is worth noting that the SEC, for the first time (we think) has used a specific formula (based on total returns) to calculate client remediation in a cherry-picking case.