The SEC, Enforcement and Statistics

The Commission’s enforcement program has increasingly relied on statistical analysis. One of its initiatives, the Aberrational Performance Inquiry or API, focuses on whether performance and other metrics fell within certain limits. In some instances it has been successful; some not. For example, in SEC v. Yorkville Advisers, LLC, Civil Action No. 12 Civ 778 (S.D.N.Y. Opinion March 29, 2018) the adviser was charged with improper valuations in an inquiry that at least in part stems from a statistical analysis under the API. On summary judgment the Court rejected virtually all of the Commission’s claims.

In other instances, however, statistics have provided important evidence in support of the Commission’s claims. Perhaps no where has the Commission been more successful with this approach than in cherry picking cases – those where a broker or adviser culls the successful trades for favored accounts while allocating the less successful ones to other accounts. That is the case in two recent actions, one against the advisory based on compliance failures and the other against the representative executing the trades. In the Matter of BKS Advisors LLC, Adm. Proc. File No. 3-18648 (August 17, 2018); In the Matter of Roger T. Denha, Adm. Proc. File No. 3-18649 (August 17, 2018).

BKS Advisor is a Commission registered representative. Mr. Denha has been an investment adviser representative at the firm since 2003. He was also a registered representative with a Commission registered broker-dealer until November 30, 3017.

From 2012 through November 30, 2017 Mr. Denha was employed at BKS. During that period he engaged in a cherry picking scheme in which he favored certain accounts, including his while disfavoring others. Specifically, he disproportionately allocated profitable trades to accounts he favored, including his, while disadvantaging others by frequently allocating them the unprofitable trades.

The scheme used an omnibus account that had been set up for the trader’s block trades. By placing the trade in this account Mr. Denha could hold it and make the allocation to specific accounts later in the day. By that point he frequently could determine the direction of the market and the price trend for a particular security. The trader would then give instructions to divide the block by essentially picking “winners” and “losers” with many of the former going to Mr. Denha’s favored accounts and more of the latter type trades being placed in the less favored accounts.

Generally, Mr. Denha placed day trades and trades that were long term or hold positions. His cherry picking scheme involved both types. At times he would have a profitable day trade in a security and a profitable hold trade in the same security. In those instances the profitable trades of both types would be disproportionately allocated to the favored accounts. The same was true if a day trade and a long term trade was not profitable in the same security.

In analyzing the trading patterns here the Commission relied in part on statistics. The difference between the allocations of profitable trades and unprofitable trades was statistically significant. The probability that such an uneven allocation of gains and losses occurred by chance is less than one-in-one-million, according to the Order. Similarly, combining both types of trades, the average combined realized and unrealized return for the favored accounts was about 1.01%. The average combined, realized and unrealized return for the disfavored accounts was a negative 0.16%. Mr. Denha made at least $412, 230 in realized and unrealized gains from the scheme.

Finally, while the firm had procedures which required that trades be fairly allocated and for the allocation of blocks, they were not properly implemented. In its daily review the firm focused on suitability and concentration, not unfair trade allocation. Since its Form ADV represented that the interests of clients would be place before those of the firm and its employees it was incorrect.

The Order as to the advisor alleged violations of Advisers Act sections 206(2), 206(4) and 207. To resolve the proceedings the adviser consented to the entry of a cease and desist order based on the sections cited in the Order, to a censure and to the payment of a penalty of $75,000.

The Order as to Mr. Denha alleged violations of Exchange Act section 10(b) and Advisers Act sections 206(1) and 206(2). To resolve the proceedings Respondent consented to the entry of a cease and desist order based on the sections cited in the order and agreed to pay disgorgement of $412,230, prejudgment interest of $35,388 and a penalty of $169,000. He is also barred from the securities business and from participating in any penny stock offering.

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