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Acting as Fiduciaries: One Investment Adviser Ignores Compliance for Personal Gain

Friday, August 30, 2019

As fiduciaries, Investment Advisers know they are ethically and legally obligated to place the interests of clients ahead of their own. Advisers also understand that the SEC provides oversight to protect investors from those in the financial industry who might pursue financial gain at the expense of those they’ve promised to serve. For James Beyersdorf and Financial Sherpa, Inc., their fiduciary failure is a hard lesson to learn from and one we can all agree not to repeat. 

James and the Giant Cherry-Picking Scheme

Founded in 2016 by James Beyersdorf, Financial Sherpa, Inc. was an Investment Adviser located in Angels Camp, California. James wore multiple hats as an owner, officer, sole employee, and thus, the control person for the advisory firm. He managed 13 clients with roughly $6.7 million in assets, of which 90% were held in ETFs while the other 10% were in short-term options. That may seem familiar to many small firms, but what stood out in James’ situation was one particular account, with one very different strategy. 

The account for James’ wife would almost exclusively trade in options, purchasing SPDR S&P 500 ETF puts and calls within a few days of expiration. Options were bought in Financial Sherpa’s omnibus trading account in the morning, allocating the trade later in the day. James would cherry-pick these trades, allocating profitable options trades to his wife’s or his account, while assigning the unprofitable options to clients.

Between October 2017 and April 2018, James and his wife had a net positive 45.2% one-day return on all options trades. During that same period, his clients had a net negative 45% one-day return on all options trades. Given the probability of this happening at random is less than one in a million – it was clear what James was doing. In May of 2018, the straw that would break the Financial Sherpa’s back would come. The broker-dealer that held the accounts terminated the relationship, forcing James to switch to a broker-dealer that required him to allocate trades at the time the omnibus trade was placed. The profit from this scheme was a total of $232,166.

The Avalanche of Penalties

Financial Sherpa’s Form ADV Part 2A had the correct fiduciary language. The filing stated that they would “never engage in trading that operates to the client’s disadvantage if representatives of [Financial Sherpa] buy or sell securities at or around the same times as clients.”  Additionally, the forms ensured fairness for all clients, and that trades would be reviewed periodically to make certain accounts were not systematically disadvantaged. The filing language was all within the intent of fiduciary obligations which Investment Advisers are bound, but it’s painfully clear those words did not mirror reality. There was no review and no concern for fairness.

For Financial Sherpa, the mountain came down in penalties of seismic proportions. For such a blatant violation of the Exchange Act and the Advisers Act, the SEC didn’t stop at stripping James of his ill-gotten gains. In addition to paying disgorgement of $232,166, he would pay prejudgment interest of $15,268 and a civil penalty of $189,427. Beyond the monetary penalties, James would subsequently be barred from the industry. He may no longer associate with any broker, dealer, investment adviser, municipal securities dealer, municipal advisor, transfer agent, or nationally recognized statistical rating organization. He may no longer serve or act as an employee officer, director, member of an advisory board, investment adviser or depositor of, or principal underwriter for, a registered investment company or affiliated person of such investment adviser, depositor, or principal underwriter. 

Use an Expert to Help Overcome the Financial Compliance Mountain

With Regulation Best Interest going into effect next June, it’s important that financial industry professionals evaluate their procedures to determine whether they are prepared to meet the new standards that help them serve the best interest of their clients. If you have questions regarding the new standards or you want help adapting your procedures, please contact Red Oak at sales@redoakcompliance.com.

About Red Oak Compliance Solutions

Red Oak Compliance Solutions is a leading provider of intelligent compliance software, offering a range of AI-powered solutions designed to help firms of all sizes successfully navigate the increasingly complex regulatory landscape. Our suite of 17(a)-4/WORM compliant features offer risk minimization, cost reduction, and process optimization capabilities with features that are designed to evolve with our client’s needs. Our flagship advertising review software enables firms to deliver compliant content to the market with confidence, faster. Our Disclosure Management and Intelligence solution simplifies the management of disclosures, while our Registration Management solution automates and streamlines the licensing and registration process, further enhancing your internal processes. 

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