Cherry–Picking Schemes: Did You Lose Money Due to This Hard-to-Spot Fraud?
Cherry-picking is a form of securities fraud. Brokers “cherry-pick” investments by watching how their trades perform throughout the day, and keep the best-performing securities for themselves or chosen investors. This allows brokers (or their friends) to fraudulently enjoy the benefits of risk-free trading while their investors suffer unfair losses. The SEC alleged in a complaint that a UCB broker allocated over $4 million in winning trades to his relatives’ accounts. Meanwhile, an estimated 75 non-preferred accounts endured $5 million in first-day losses.
Cherry-picking schemes are the kind of behind-the-scenes fraud that can go undetected for years, with no way for investors to detect it.
How Does Cherry-Picking Get Caught?
Investors largely rely on regulators to detect cherry-picking. SEC Enforcement Division Asset Management Unit Julie Riewe has stated: “Cherry-picking schemes can be extremely difficult to detect without an investor astutely noticing that something may be amiss and coming to us with a complaint about the adviser.” This statement came after an SEC initiative to catch cherry-picking. By analyzing trading patterns, the SEC determined that certain trade allocations could not have happened by chance—cherry-picking must have occurred.
Joseph G. Sansone, Chief of the SEC Enforcement Division’s Market Abuse Unit, said in an SEC complaint, “The SEC uses sophisticated analytical tools to ferret out investment professionals who abuse their positions to engage in cherry-picking and other fraudulent conduct.”
Brokerage Firms and Regulatory Rules
Brokerage firms also play a role in catching signs of cherry-picking.
Cherry-picking violates regulatory rules designed to protect markets from unfair practices. Regulators require that firms have supervisory systems in place to catch cherry-picking schemes. If the SEC picks up on trading patterns that indicate cherry-picking, the brokerage firms could face serious fines and penalties. Brokers who cherry-pick are typically ordered to return their ill-gotten gains and may suffer additional penalties.
Besides regulatory rules, investment agreements with brokerage firms stipulate that brokers will not favor any accounts. Continuum, one firm that the SEC alleges engaged in cherry-picking, had an agreement with brokers stating, “Continuum would ensure fairness; would not engage in trading that operated to disadvantage clients; and would employ documentation and review protocols to prevent conflicts of interest.” Despite this, the SEC alleges that Continuum’s Chief Operating Officer engaged in a cherry-picking scheme for over a year. This resulted in the COO enjoying first-day trading profits while his customers suffered negative trading returns.
Why Does Cherry-Picking Go Undetected?
Evidence suggests there is not enough regulation to reliably catch cherry-picking. Strong Investment Management (SIM) made trades using an omnibus account, which is an account that allows a firm to place trades for multiple accounts. According to the SEC Complaint, the SIM trader cherry-picked trades, while his brother, the financial professional in charge of reviewing the firm’s trading practices, only performed “spot checks.” As a result of these findings, the SEC barred the trader and ordered Strong Investment Management to return its fraudulent profits.
The trading platform suspected Strong Investment Management of fraudulent cherry-picking and banned them from using their platform. The platform confronted the firm’s sole trader after he allocated all the trades from a block transaction to his own account—an action that suggests cherry-picking. After his termination from the platform, the trader simply informed his customers that SIM was too small of a brokerage firm for the platform. This lie allowed the fraud to continue until the SEC caught on to the irregular trading patterns.
Who is Most Likely to Fall Victim to Fraudulent Cherry-Picking?
Pension funds may be especially vulnerable to cherry-picking schemes, especially because they usually belong to elderly clients. The SEC reports that cherry-picker Alan Bond used his ill-gotten gains from pension funds to purchase “75 luxury and antique automobiles and a large home and beachfront condominium in Florida.”
Alan Bond started his career as a promising money manager with a degree from Harvard. While out on bail for a $6 million commission kickback scheme, Bond found new victims through two pension funds, and according to a source quoted in PIABA, he may have courted his clients with “lavish entertainment.” With his reputation as a talented financial manager, his investors may have simply trusted Bond to manage their money appropriately. Before the kickback fraud was discovered, Bond managed $600 million in client assets.
The SEC alleges that Alan Bond’s cherry-picking made him $6.3 million while his clients lost $56 million. In 2003, a district court judge sentenced Alan Bond to 12 years and seven months in prison.
When to Contact a Securities Lawyer
Do you suspect your broker of cherry-picking? If you scrutinize your portfolio and notice a disproportionate number of losing trades, contact a securities lawyer for a case evaluation. Case evaluations are free, and a securities lawyer at Kurta Law can help you decide if you need to move forward with a cherry-picking securities fraud case.