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Friday, March 30 2018

SEC’s Cherry-Picking Initiative Nets 715K from Austin-Based Adviser

The SEC’s enforcement initiative against “cherry-picking” has reached Austin, Texas. In its fourth such action since launching the data-drive initiative in 2015, the SEC has charged Robert Magee, the sole owner and employee of RIA Valor Capital Asset Management, with improperly allocating day-trades to benefit his personal accounts at the expense of his clients. According the SEC, Magee’s schemed involved purchasing blocks of securities through Valor’s omnibus account and then waiting “until after the relevant security’s intraday price changed” to allocate the block:

“Magee predominantly allocated the most unprofitable trades to Valor’s clients to their detriment while allocating profitable or less unprofitable trades to his personal account…If the relevant security’s price went up, Magee typically sold the position and allocated both trades (i.e., the purchase and sale) to his personal account thereby realizing a gain. Conversely, when the security’s price went down over the course of the day, Magee would typically either: (a) sell the security the same day and allocate both the purchase and sale to Valor clients, leaving them with a loss; or (b) hold the security and allocate the purchase to Valor clients, effectively leaving those clients with unrealized first-day losses.”
Magee’s conduct is perhaps best represented by the series of investment the advisor made in one El Polo Loco Holdings, Inc. (“LOCO”):

Trade Date Shares Profit Allocation
Monday, July 28, 2014 9,000 $8,073.90 Magee
Tuesday, July 29, 2014 6,000 $1,453.20 Magee
Wednesday, July 30, 2014 3,000 $2,511.60 Magee
Thursday, July 31, 2014 3,000 $2,774.10 Magee
Friday, August 1, 2014 4,000 $3,325.20 Magee
Monday, August 4, 2014 3,000 -5,076.00 Clients

Spot the pattern? From July 2012 to January 2015, Magee’s personal accounts enjoyed first-day profits of nearly 350K while Valor Capital clients suffered first-day losses of nearly 550K. According to the SEC, “Magee’s personal account was allocated 459 trades, of which 81.9%, or 376, were profitable based on the end of day price.” Meanwhile “Valor client accounts were allocated 1,365 trades, of which only 16%, or 219, were profitable based on the end of day price (or closing transaction price for day-trades).” What are the odds of this disparity occurring by chance? Less than 1 in a Trillion according to the SEC.

By August 2016, the Texas State Securities board had already hit Valor with $48,000 fine for failure to enforce Valor’s written supervisory procedures concerning trade allocation. No data exists on the likelihood that the SEC will discover your fraudulent cherry-picking scheme after you fail to enforce your own WSPs regarding trade allocation, but you can bet the chances are better than 1 in a trillion.

Magee’s conduct– knowingly or recklessly misallocating trades to the benefit of his account and at the expense of his clients’ – is a violation of “Section 10(b) of the Exchange Act and Rule 10b-5(a) and (c) thereunder, which prohibit fraudulent conduct in connection with the purchase or sale of securities.” It’s also a violation of Section 206(1) of the Advisers Act, which prohibits investment advisers from “employing any device, scheme, or artifice to defraud any client or prospective client” and Section 206(2) of the Advisers Act, “which prohibits investment advisers “from engaging in any transaction, practice or course of business which operates as a fraud or deceit upon any client or prospective client.” For these violations, Magee has been barred from the industry and order to pay disgorgement, prejudgment interest, and a civil penalty totaling more than $715,000.

At Red Oak, we can recommend Written Supervisory Policies designed to ensure that your Adviser does not, either wittingly or unwittingly, allocate trades in a manner inconsistent with your fiduciary duty or other provisions of state and federal law. If you have any questions about trade allocation or any concerns regarding your Written Supervisory Procedures, please call us at 888.302.4594 or email us at sales@redoakcompliance.com, and we will be happy to assist.