SEC Charges Former Chief Investment Officer of Registered Investment Adviser with Fraud

Who may be interested: Registered Investment Companies; Registered Investment Advisers; Broker-Dealers; Boards of Directors 

Quick Take: The SEC recently charged a former co-chief investment officer (CIO) of a registered investment adviser (Adviser) for allegedly operating a multi-year fraudulent cherry-picking scheme and violating fiduciary obligations to clients of the Adviser. 

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According to the SEC’s Complaint (Complaint), the CIO, named as a portfolio manager for several of the Adviser’s investment strategies, engaged in a “cherry-picking” scheme in allocating trades to clients from January 2021 until October 2023. Cherry-picking occurs when favorable trades are allocated to certain portfolios and unfavorable trades are assigned to others. From 2021 to 2023, the CIO assigned over $600 million of gains to favored portfolios and $600 million of losses to disfavored portfolios. The portfolios included mutual funds, private funds, separately managed accounts, as well as pension funds and institutional accounts.

The Complaint alleged that the CIO placed trades with brokers early in the morning via phone calls but routinely failed to allocate and properly document the transactions at the time of the trades, as required by the Adviser’s policies. The CIO waited several hours before assigning the trades placed in a combined omnibus account to the appropriate portfolios. During that time, the CIO observed the price movements of the trades and would then assign trades at a first-day gain to favored higher-fee portfolios and trades at a first-day loss to lower-fee portfolios. Because of the difference in fee structures, each dollar in assets under management in the favored higher-fee portfolios could generate approximately four times as much revenue for the Adviser as each dollar in the lower-fee portfolios. The Complaint alleged that the CIO stood to profit significantly from this cherry-picking scheme, both professionally and financially, because his compensation was tied to the Adviser’s revenue. The Complaint also alleged that the CIO’s method of trade allocation was not disclosed to clients.

The Complaint charged the CIO with violating antifraud and other provisions of the federal securities laws. The Complaint emphasized that the CIO’s cherry-picking scheme amounted to a significant breach of fiduciary duty, which includes the duty of good faith and to act in the best interest of clients, as well as a duty to provide full and fair disclosure of all material facts.

The Complaint seeks permanent and conduct-based injunctions, an officer-and-director bar, disgorgement, prejudgment interest, and civil penalties.

Separately, the CIO also faces criminal charges for fraud and making false statements in a parallel action brought by the U.S. Attorney’s Office for the Southern District of New York.

The SEC’s Complaint announcing the charges can be found here.