SEC Uses Statistical Analysis To Support Cherry Picking Action
The Commission in recent years has focused in part on developing its data analysis capabilities to inform its enforcement investigations and actions. On place where those efforts are frequently on display is in so-called “cherry picking” cases. Those actions center on, for example, a trader allocating profitable trades to the account of one or more favored clients while the unprofitable trades are placed in other accounts. In a series of cases the Commission has used statistical analysis to illustrate the disproportionate nature of the allocations or the probability that the allocations would have been as disproportionate as account records reflect. The latest case using this approach is In the Matter of Joseph C. Buchanan, Adm. Proc. File No. 3-19377 (August 26,2019).
Respondent Buchanan was an investment adviser representative at Laurel Wealth Advisors, Inc., a registered investment adviser, in La Jolla, California for about four years beginning in November 2011. FINRA suspended Respondent for a two year period beginning in late 2013 for failure to satisfactorily respond to a request for information.
In 2012 Mr. Buchanan began using an omnibus account at LWA’s broker to acquire a large block of shares that would later be allocated to his clients and personal account. The trader would at times delay the allocation of shares until after the market close or even the next day. Trades that became profitable later the same day were disproportionately allocated to Mr. Buchanan’s personal account. When trades became unprofitable during the same day they were disproportionately allocated to client accounts.
By February 2012, LWA’s broker told the trader that the allocations should be made on the trade date. Nevertheless, Mr. Buchanan continued to delay allocations beyond one hour past the close of the trading day. Accordingly, the broker contacted the advisory. Despite repeated warnings, the practice of making late allocations continued. Eventually the broker suspended use of the omnibus account for one month in February 2015. When the privilege of using the omnibus account was restored, the late allocation practice resumed. The Advisory then suspended Mr. Buchanan’s account indefinitely. Two months later, in August 2015, the trader resigned.
During a two year period beginning in March 2013 the allocations from Mr. Buchanan’s omnibus account to his personal account had same-day realized and unrealized gains of 0.89% or $56,075 in same-day profits. During the same period the allocations to client accounts had same-day realized and unrealized losses of -0.13%, or a combined same-day loss of -$60,821. As a result of his allocations the trader had ill-gotten gains of at least $56,227 — the difference between the same-day realized and unrealized profits and his pro rata share of cumulative losses on all trades in the omnibus account during the period. The “realized and unrealized gains for allocations to Buchannan’s personal accounts are statistically significant in that the likelihood of these same-day profitable trades being randomly allocated to his personal accounts are less than one in one billion,” according to the Order. The Order alleges violations of Advisers Act Section 206(1) and 206(2).
Respondent resolved the proceedings, consenting 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. Mr. Buchanan will pay disgorgement of $56,227.00 and prejudgment interest of $15,284.03. Payment of these amounts, except for $40,000, is waived based on an affidavit of financial condition.