The U.S. Securities and Exchange Commission (SEC) has conducted several publicized investigations focused on broker and investment adviser or advisor cherry-picking in recent years. Most recently, the SEC announced on August 10, 2022, that an investment advisor providing investment advisory services in Florida agreed to settle charges related to an alleged multi-year cherry-picking scheme through which he fraudulently diverted hundreds of thousands of dollars in investment returns.

As the Securities and Exchange Commission (SEC) explained in its Press Release, “from January 2011 to October 2020, [investment advisor representative Richard Keith] Robertson disproportionately allocated profitable trades to his personal and family accounts and disproportionately allocated unprofitable trades to certain of his client's accounts. According to the orders, the likelihood of these profitable trades being randomly allocated to Robertson's personal and family accounts is nearly zero.” The SEC also found that Robertson’s firm, IFP Advisors, LLC, “failed reasonably to supervise Robertson and failed to implement policies and procedures reasonably designed to prevent unfair trade allocations.”

Based on these allegations, among others, Robertson agreed to disgorgement, penalties, and interest totaling over $900,000, as well as multiple securities industry bars. IFP Advisors, LLC consented to a $400,000 penalty, cease-and-desist order, and retention of an independent compliance consultant. While these penalties are substantial, they are not as severe as they could have been—as the Securities Exchange Act of 1934 and other pertinent laws allow for criminal prosecution in appropriate cases.

“Cherry picking is a form of securities fraud that implicates multiple federal securities laws and regulations. In addition to imposing steep penalties for brokers who cherry pick, these laws and regulations impose steep penalties for brokerage firms that fail to prevent and detect cherry picking as well.” – Dr. Nick Oberheiden, Founding Attorney of Oberheiden P.C.

This case is just one of several recent examples. While the SEC targets brokers, investment advisors, and firms for all types of investor fraud, it is clearly making cherry-picking a priority. When facing cherry-picking investigations, targeted individuals and firms need to ensure that they have a clear understanding of the specific factual allegations at issue, and they must work with experienced defense counsel to ensure that they defend themselves by all means available.

More Recent SEC Cherry Picking Cases

By examining the SEC’s recent publicized cherry-picking cases, it is possible to identify trends in the Commission’s enforcement tactics and priorities. Examining the outcomes of these cases also provides critical insights for formulating defense strategies during SEC cherry-picking investigations and enforcement proceedings. Some additional examples of the SEC’s recent cherry-picking cases include:

Miami-Based Investment Advisor and Firms Charged with Perpetrating $5 Million Cherry Picking Scheme

In June 2021, the SEC announced that it had filed fraud charges and obtained an asset freeze and other emergency relief against a Miami-based investment advisor and two investment firms accused of perpetrating a $5 million cherry-picking scheme. According to the SEC, the defendants “engaged in a scheme since at least September 2015 to divert profitable trades to two accounts believed to be held by [the advisor’s] relatives and saddle other clients with losing trades.” The SEC further alleged that:

“The defendants . . . used a single account to place trades without specifying the intended recipients of the securities at the time they placed the trades. . . . [A]fter the defendants established a position, if the price of the securities increased during the trading day, the defendants usually closed out the position and allocated those profitable trades to the two preferred accounts. Conversely, the complaint alleges that if the price of the securities decreased during the trading day, the defendants usually allocated the unprofitable trades to other client accounts.”

The SEC’s complaint included charges under Sections 17(a)(1) and (3) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934, Sections 206(1) and (2) of the Investment Advisers Act of 1940, and SEC Rule 10b-5(a) and (c), and sought permanent injunctions, disgorgement, prejudgment interest, and civil monetary penalties.

SEC Wins Bench Trial Against Louisiana Advisors and Advisory Firm Accused of Cherry Picking

In January 2021, the SEC secured a judgment against two Louisiana investment advisors and their advisory firm in a case involving cherry-picking allegations. The case centered on allegations that the advisors “intentionally allocated profitable trades to favored accounts, including [one of the advisor’s] own, while allocating unprofitable trades to two accounts with substantial assets controlled by one client.” The court also found that the defendants misrepresented that they “were not trading in the same securities as [the firm’s] clients, and further found that the defendants' scheme violated the firm's stated trading policies.”

Based on its findings, the court ordered the defendants to pay approximately $800,000 in disgorgement, interest, and penalties, and it enjoined each of the defendants from committing future violations of Sections 17(a)(1) and (2) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934, Rule 10b-5, and Sections 206(1) and (2) of the Investment Advisers Act of 1940.

California Investment Advisor Charged with Cherry Picking, Firm Charged with Failure to Supervise

In August 2019, the SEC settled charges against a California registered investment adviser and his investment company or firm related to allegations that the advisor cherry-picked same-day profits for himself while allocating same-day losses to his clients. Notably, in this case, the SEC also focused on the likelihood of such an outcome resulting from ordinary market forces, finding that, “the likelihood of these profitable trades being randomly allocated to his personal accounts are less than one in one billion.”

In addition to charging the advisor with violations of Sections 206(1) and 206(2) of the Investment Advisers Act of 1940, Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5(a) and (c), the SEC also charged the advisor’s firm with making misleading statements and failing to implement adequate written policies and procedures in violation of Section 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-7. The advisor consented to a permanent bar, a cease-and-desist order, disgorgement, and interest, while the firm consented to a censure, cease-and-desist order, and a $100,000 penalty. Investor losses totaled $56,227 according to the SEC.

SEC Settles Charges Against Another California Investment Advisor for More Than $1 Million

In another case settled in August 2019 and involving another California-based investment advisor and firm, the SEC charged the defendants with conducting a cherry-picking scheme resulting in nearly $1 million in fraudulent losses for investors. The case stemmed from an SEC investigation concluded in 2018, following which the Commission alleged that the advisor “traded securities in [the firm’s] omnibus account but delayed allocating the securities to specific client accounts until he had observed the securities' performance over the course of the day . . . reap[ing] substantial profits at his clients' expense by ‘cherry picking’ the trades, allocating the profitable trades to himself and the unprofitable trades to [the firm’s] clients.”

In this case, the SEC also focused on the advisor’s and firm’s disclosure practices—noting that they both “misrepresented their trading and allocation practices in the firm's Forms ADV, including by falsely stating that all trades would be allocated in accordance with pre-trade allocation statements and that the firm did not favor any account, including those of the firm's personnel.” Based on the SEC’s allegations, the advisor and firm agreed to joint and several liabilities for more than $1 million in disgorgement and interest, and the advisor agreed to pay an additional $184,767 civil penalty.

Common Allegations in SEC Cherry Picking Cases

As demonstrated by the case summaries above, the SEC’s recent cherry-picking cases have largely involved similar substantive allegations under the same set of statutory and regulatory rules and prohibitions. Whether trading on their own account or for the benefit of family members or business associates, advisors and brokers accused of cherry-picking can face a laundry list of charges, while their firms can face an even greater number of charges if they facilitate or fail to take adequate steps to prevent cherry picking. Based on the SEC’s recent case history, likely charges in cherry-picking cases include violations of:

• Section 10(b) of the Securities Exchange Act of 1934
• Sections 206(1) and 206(2) of the Investment Advisers Act of 1940
• Section 206(4) of the Investment Advisers Act of 1940
• SEC Rule 10b-5(a) and (c),
• SEC Rule 206(4)-7

Potential Defenses to SEC Allegations of Cherry Picking

While SEC cherry-picking investigations can lead to multiple statutory and regulatory charges, targeted individuals and firms will often be able to assert multiple defenses as well. In some cases, investors and the SEC’s suspicions of cherry-picking will simply be misguided. In others, firms may be able to defend against allegations of complicity or non-compliance by demonstrating good-faith adherence to a comprehensive SEC compliance program. In others still, individuals and firms may be able to avoid disgorgement and other penalties by raising questions about the adequacy of the SEC’s evidence or challenging the SEC’s investigative practices. Ultimately, the defenses available in any particular case will depend on the specific circumstances involved, and targeted individuals and firms will need to work closely with their defense counsel to make informed decisions about how best to proceed.