SEC Files Two Cherry Picking Actions, Aided by Statistical Analysis
The Commission has continued to use statistical analysis to bolster its enforcement claims. One area in which this has been done is “cherry picking” cases. Two recently filed settled actions involving investment advisers are examples.
In the Matter of Howarth Financial Services, LLC, Adm. Proc. File No. 3-18172 (Sept. 12, 2017) is an action against Howrath Financial, a state registered adviser, and its founder, principal and sole owner, Gary Howarth. The action centers on the period from late March 2012 through early July 2013. During the period Respondents used two approaches to cherry pick trades. In the first Mr. Howarth allocated favorable purchases to his personal accounts while losing trades went to those of the clients. In most cases if the price of the security went up during the day it was sold with the proceeds being allocated to personal accounts. If the price declined, the security was allocated to client accounts but not sold.
The second method involved the use of an omnibus account to first sell and then purchase shares of the same security. The process began generally with the sale of a security held in firm client accounts but not in Mr. Howarth’s personal accounts. An omnibus account was used. If the price declined Respondent purchased the same number of shares at the lower price and then allocated the trade to his personal account. That allocated the profit to the personal account. If the price did not decline no purchase was made. Rather, Mr. Howarth typically allocated the sale to the client accounts.
The difference between Mr. Howarth’s first-day returns and those of his clients is highly statistically significant. The probability that the disproportionate allocation of favorable trades was due to chance is less than one in a billion.
Mr. Howarth’s success rate was significantly better than that of his clients. During the period his personal accounts were allocated 623 day trades of which 88.4% were profitable. The client accounts were allocated just four day trades of which only one was profitable. During the same period client accounts were allocated 302 losing trades while the personal accounts had just 19 unrealized trades, all of which were loosing transactions. Subsequently, the brokerage firm used by Respondents terminated the relationship. Respondents made about $38,172. The Order alleges violations of Exchange Act Section 10(b) and Advisers Act Sections 206(1) and 206(2).
To resolve the matter each Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order. Mr. Hawarth was also barred from the securities business. Respondents were also, on a joint and several basis, ordered to pay disgorgement of $38,172, prejudgment interest and a penalty of $160,000.
In the Matter of Jeremy A. Licht, Adm. Proc. File No. 3-18171 (Sept. 12, 2017). Mr. Licht is the founder, principal, COO and owner of JL Capital Management, a sole proprietorship and a registered investment adviser. From January 2011 through September 2012 one broker was used for trading; between October 2012 and March 2016 a second broker was used to custody trades.
Trades were made and allocated using an online platform from the brokerage. By trading in an omnibus account and delaying allocation to a specific account until the intra-day performance could be observed, Mr. Lichht executed a fraudulent cherry picking scheme. For example, while the accounts were at the first broker Mr. Licht’s total first day profits – realized and unrealized – were at least $35,933, representing a 1.01% return. In contrast the clients suffered aggregate unrealized first day looses of $77,700, representing a -2.15% return. Similar results occurred while the accounts were at the second broker. The difference tween Mr. Lieht’s first-day returns and that of his clients is statistically significant. The probability that the disproportionate allocation of favorable trades to Mr. Licht and the first broker was due to random change was less than one in a trillion; for broker two its was less than one in a million. Since 2012 Mr. Licht has reaped at least $88,504.
Mr. Licht admitted to the scheme in testimony. The Order also alleges that false statements were made in Forms ADV. Those Forms represented that accounts would not be favored in the allocation process. The Order alleges violations of Exchange Act Section 10(b) and Advisers Act Sections 206(1) and 206(2).
To resolve the matter Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order. He was also barred from the securities business. In addition, he agreed to pay disgorgement of $88,504, prejudgment interest and a penalty of $181,000.