Enforcement News: Spotlight on “Cherry-Picking”Print Article
- Posted on: Jun 21 2021
Cherry picking is the process of selecting securities to invest in by mimicking the trading of other investors (both individual and institutions) who are successful over a long period of time. In other words, cherry-pickers base their trading around the techniques and strategies of other investors.
Anyone can implement a cherry-picking strategy. Indeed, cherry picking is used by both professional and retail investors alike.
Cherry picking can be an effective way to generate returns. It can also be helpful for novice investors – i.e., investors who are unfamiliar with the process of stock selection and investment research.
Cherry picking can also be used by investment advisers in a fraudulent way. Under this scenario, an investment adviser will allocate winning trades to his/her personal account or to a favored client(s) at the expense of other clients.
Typically, an investment adviser trades in securities through an omnibus trading account. An omnibus trading account allows an investment adviser to buy and sell securities on behalf of multiple clients simultaneously, without identifying to the broker in advance the specific accounts for which a trade is intended. For example, if an adviser separately purchases the same security for several clients on the same day, the adviser might obtain different prices on each transaction as a result of normal market fluctuation. Rather than placing individual orders in each client account, the adviser can place an aggregated order, or “block trade,” in the omnibus account and subsequently allocate the trade among multiple accounts using an average price. When used properly, an adviser will fairly and equitably allocate the block trade among client accounts, ensuring that no account receives preferential treatment over another.
The fraudulent act of cherry picking involves an investment adviser selecting specific profitable or unprofitable trades and allocating them in a manner of their choosing. For example, the investment manager might allocate the profitable trades to his/her personal account or to certain clients in order to give them preferential treatment. Conversely, trades that incur losses might be allocated to the accounts of less preferred clients of the investment adviser.
When used fraudulently, cherry picking violates the securities laws. Indeed, the Securities and Exchange Commission (“SEC” or the “Commission”) has been vigilant in cracking down on investment advisors who engage in fraudulent cherry picking.
In January 2017, the SEC charged Michael J. Breton and his firm Strategic Capital Management, LLC with fraud for engaging in a cherry-picking scheme whereby Breton placed trades through a master brokerage account and then allocated profitable trades to himself and unprofitable trades to client accounts (here). According to the SEC, defendants defrauded their clients out of approximately $1.3 million. On September 6, 2019, the U.S. District Court for the District of Massachusetts entered final judgment against defendants (here).
In September 2018, the SEC filed a complaint in the Western District of Louisiana against Lafayette, Louisiana-based World Tree Financial, LLC and its majority-owner and co-founder, Wesley Kyle Perkins, for operating a cherry-picking scheme that defrauded World Tree clients (here). According to the SEC, for more than four years, Perkins enjoyed substantial profits at his clients’ expense by cherry-picking trades. Perkins allegedly traded securities in World Tree’s omnibus account and delayed allocating the securities to specific client accounts until he had observed the securities’ performance over the course of the day. He then allocated profitable trades to favored accounts, like his own, while allocating unprofitable trades to two accounts with substantial assets controlled by one person. The SEC also alleged that World Tree and Perkins made false and misleading statements about their trade allocation practices – i.e., that all trades would be allocated fairly and equitably. In addition, the SEC alleged that World Tree, Perkins and Priscilla Gilmore Perkins, Perkins’ wife and the firm’s co-founder and co-owner, falsely represented that they were not trading in the same securities as World Tree’s clients. On January 15, 2021, following a week-long, bench trial, the court entered final judgment in favor of the SEC against World Tree, Wesley Perkins, and Priscilla Perkins (here). The court ordered Wesley Perkins and World Tree to pay civil penalties of $160,000 and $300,000, respectively, ordered them to disgorge, $347,947, plus prejudgment interest jointly and severally, and enjoined them from future violations of the securities laws.
On August 21, 2019, the District Court for the Central District of California entered a settled final judgment against Strong Investment Management (“Strong”) and its owner, Joseph B. Bronson (“Bronson”), both of whom the SEC previously charged with securities fraud for their involvement in a cherry-picking scheme (here). According to the SEC (here), which commenced the action in February 2018, 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. As alleged, Bronson enjoyed substantial profits at his clients’ expense by cherry picking the trades, disproportionately allocating profitable trades to himself and unprofitable trades to Strong’s clients. The SEC also alleged that Strong and Bronson misrepresented their trading and allocation practices in the firm’s Forms ADV, including by falsely stating 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.
Less than one week later, on August 26, 2019, the SEC announced (here) that Laurel Wealth Advisors, Inc., a registered investment adviser based in La Jolla, California, and its former investment adviser representative, Joseph C. Buchanan, agreed to settle charges relating to Buchanan’s multi-year cherry-picking scheme. According to the SEC, from at least March 2013 to June 2015, Buchanan disproportionately allocated profitable trades to his personal accounts, and disproportionately allocated unprofitable trades to his clients’ accounts. The SEC found that Buchanan’s allocation scheme resulted in $56,075 in net same-day profits to Buchanan and $60,821 in net same-day losses to his clients.
Last week, on June 17, 2021, the SEC announced that it obtained an asset freeze and other emergency relief, and filed fraud charges, against a Miami-based investment professional and two investment firms for engaging in an alleged cherry-picking scheme in which they funneled millions of dollars in trading profits to preferred accounts (here).
In the complaint filed by the SEC in the Southern District of Florida (here), the SEC alleged that defendants Ramiro Jose Sugranes (“Sugranes”), UCB Financial Advisers Inc., and UCB Financial Services Limited engaged in an approximate six-year scheme to divert profitable trades to two accounts believed to be held by Sugranes’ relatives, while at the same time saddling other clients with losing trades. Defendants allegedly used a single account to place trades without specifying the intended recipients of the securities at the time they placed the trades. As alleged, after defendants established a position, if the price of the securities increased during the trading day, defendants usually closed out the position and allocated those profitable trades to the two preferred accounts. Conversely, said the SEC, if the price of the securities decreased during the trading day, defendants usually allocated the unprofitable trades to other client accounts. According to the SEC, the preferred clients, who were named as relief defendants, received approximately $4.6 million from profitable trades, while other clients sustained more than $5 million in first-day losses. By its complaint, the SEC seeks to recover the relief defendants’ unlawful gains, plus prejudgment interest.
The SEC alleged that Sugranes and the two UCB entities violated the antifraud provisions of the federal securities laws. As against Sugranes and the UCB entities, the SEC is seeking permanent injunctions, disgorgement, prejudgment interest, and civil penalties. On June 14, the court granted the SEC’s request for emergency relief, including an asset freeze, accounting, and expedited discovery.