SEC Makes Its First Bust in New Data-Driven Push.
The Securities and Exchange Commission announced Monday its first enforcement action as a result of the agency's data-driven initiative to detect advisors' fraudulent trade allocations known as cherry picking.
The agency brought fraud charges Monday against a Wisconsin-based investment advisory firm and its owner accused of improperly allocating to his personal and business accounts certain options trades that appreciated in value during the course of a trading day while allocating to his clients other trades that depreciated in value.
Under the data-driven initiative, economists in the agency's Division of Economic and Risk Analysis along with enforcement investigators analyze large volumes of investment advisors' trade allocation data to detect whether the advisor is disproportionately allocating profitable trades to favored accounts. The cherry picking initiative is being led by the Asset Management Unit and the regional offices in Boston and Los Angeles.
In the Monday action, the SEC Enforcement Division alleges that Mark P. Welhouse purchased options in an omnibus or master account for Welhouse & Associates Inc. and delayed 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.
Welhouse allegedly reaped $442,319 in ill-gotten gains by "unfairly allocating options trades in an S&P 500 exchange-traded fund named SPY," the SEC states. His personal trades in these options had an average first-day positive return of 6.28%, while his clients' trades in these options had an average first-day loss of 5.05%.
As described in the SEC order instituting administrative proceedings against Welhouse and his firm, SEC staff conducted a statistical analysis to determine whether Welhouse's profitability in these accounts could have resulted from a coincidental or lucky combination of trades. After running a simulation test 1 million times, the staff concluded it could not.
"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 advisor," said Julie Riewe, co-chief of the SEC Enforcement Division's Asset Management Unit.
"We devised this initiative to identify specific custodians providing services to investment advisors 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." The Asset Management Unit is also using data analytics analysis in three other areas:
* Aberrational Performance Inquiry: uses proprietary risk analytics to identify hedge funds with suspicious returns;
* Undisclosed Advisor Revenue: to address certain conflicts, AMU and exam staff developed this risk-analytic initiative that targets undisclosed compensation arrangements between investment advisors and brokers that result in potentially tainted investment advice; and
* Distribution in Guise: Developed by AMU in collaboration with exam staff and Division of Investment Management is a risk-analytic initiative that identifies advisors that might be causing funds to violate Rule 12b-1 by using fund assets to make distribution payments to intermediaries outside of the funds' Rule 12b-1 plan, whether funds' boards are aware of such payments, and how such payments are disclosed to shareholders.
The SEC Enforcement Division alleges that Welhouse and his firm violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, Section 17(a) of the Securities Act of 1933, and Sections 206(1) and 206(2) of the Investment Advisers Act of 1940.
The SEC says that the matter will be scheduled for a public hearing before an administrative law judge for proceedings to adjudicate the Enforcement Division's allegations and determine what, if any, remedial actions are appropriate.
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|Date:||Jun 30, 2015|
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