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Monday, November 27 2017

SEC Orders Adviser to Pay More than $170,000 for Failing to Supervise Representative Who Cherrypicked Investments

The SEC has ordered investment adviser Canterbury Consulting, Inc. (“Canterbury,” “Adviser”) to pay disgorgement, prejudgment interest, and a civil penalty in amounts totaling $172,986.00. The SEC’s order stems from Canterbury’s failure to reasonably supervise IAR Kenneth P. Krueger as required under the Adviser’s Act of 1940 (“Adviser’s Act,” “The Act”), its failure to maintain books and records as required under the Act, and its failure to adopt and implement written policies and procedures reasonably designed to prevent violations of federal securities laws.

From at least January 2013 through November 2014, Krueger disproportionately allocated profitable trades to his personal accounts and unprofitable/less profitable trades to 42 brokerage customer and advisory client accounts (“discretionary accounts”). The fraudulent scheme, otherwise known as “cherry-picking,” involved Krueger’s use of Canterbury’s omnibus trading account to execute “block” trades and then allocate portions of such trades to his and other accounts in a manner that disproportionately benefited his own personal accounts. When a security appreciated in value on the day of purchase, Krueger would sell the security on the same day and improperly allocate a disproportionate number of such profitable day trades to his personal accounts. Meanwhile, when a purchased security did not appreciate on the day of purchase, Krueger would improperly allocate a disproportionate number of the purchases to one or more discretionary accounts.

During the period of time at issue in the SEC’s order, Krueger allocated approximately 95% of trades after the close of trading on the NYSE and other trading platforms, assigning 87% of the profitable day trades to his own accounts and 99% of unprofitable trades to discretionary accounts. The SEC’s order notes no finding of any difference in investment strategy that would justify such disparate performance and adds that “the probability of observing such an uneven allocation of profitable trades by chance is less than one-in-one million.”

While Krueger repeatedly enriched his own accounts through a fraudulent misallocation of profitable/unprofitable trades, Canterbury’s own compliance manual failed to include any policies and procedures designed to address Krueger’s trading or the supervision of any persons trading in the omnibus account. Moreover, Canterbury had not tasked any person at the firm with supervising Krueger or his trading process.

Besides Canterbury’s failure to supervise Krueger or maintain policies and procedures reasonably designed to prevent his violations of the Adviser’s Act, the SEC also cited Canterbury for failure to maintain any record of clients or prospective clients to whom the firm had offered or delivered its Form ADV Part 2. Thus, Canterbury committed three separate violations:

  1. Violation of Section 204(a) of the Advisers Act and Rule 204-2(a)(14) promulgated thereunder, which requires registered investment advisers to keep a “record of the dates that each brochure and brochure supplement…was given to any client or to any prospective client who subsequently becomes a client”;
  2. Violation of 203(e)(6) of the Advisers Act, which required registered investment advisers to “supervise, with a view to preventing violations of any provision of [various securities acts…] another person who…is subject to [its] supervision,” and;
  3. Violation of Section 206(4) of the Advisers Act and Rule 206(4)-7 thereunder, which requires registered investment advisers to “adopt and implement written policies and procedures reasonably designed to prevent the violation of federal securities laws…”

Apart from the provisions referenced above, State and Federal law has imposed an extensive set of rules and regulations with which investment advisers and broker dealers must comply or face serious consequences. As the Canterbury case demonstrates, firms may even find themselves in hot water over the undisclosed misconduct of any number of employees. If you have questions regarding your compliance obligations or how to implement policies and procedures that adequately protect your firm, please call us at 888.302.4594 or email us and we will be happy to assist.