SEC Charges Tied to the Lack of An Algorithm

by Dorsey & Whitney LLP

High speed trading and the use of algorithms is a key topic of debate. An investment strategy centered on an algorithm for use in the currency markets is at the center of a settled administrative proceeding filed by the Commission. The difficulty in the case was not high speed trading or the algorithm. It was that the algorithm did not exist. In the Matter of Chariot Advisors, LLC, Adm. Proc. File No. 3-2014 (July 3, 2014).

Chariot Advisors is a registered investment adviser. Respondent Elliot Shifman was its sole owner from September 2008 through the end of June 2009. In late 2008 Mr. Shifman approached Northern Lights Variable Trust, a registered open-ended management investment company, with a request that it create the Chariot Fund as a series with Chariot Advisors as the new fund’s advisor.

In response to a request for additional information Mr. Shifman prepared a presentation for the Board, detailing the proposal. The presentation represented in part that the new fund would be “a currency overlay product” and would use a trading algorithm similar to one in use by another party. The new fund would thus be a "byproduct of extensive research of recent changes in FX market structure due to the adaption of algorithmic and high frequency trading" the presentation claimed. The representations were reiterated by Mr. Shifman at a Board meeting.

The board approved the Chariot Fund as a series of Northern Lights. Chariot Advisors was approved as the adviser.

Subsequently, Mr. Shifman took steps to sell Chariot Advisors. He entered into a contract in mid-May 2009 for the sale, effective June 30, 2009. In view of the contract the Board requested a second presentation. The second presentation largely reiterated the statements from the first. At the time of the presentation the Fund had prepared a draft prospectus for the proposed mutual fund. It essentially restated the statements made to the board by Mr. Shifman regarding algorithmic trading with some modifications.

On July 15, 2009 Chariot Fund launched. Chariot Advisors funded it by reallocating about $17 million in assets in clients’ annuities. The new fund operated for two months, conducting currency trading using technical analysis. It did not use an algorithm.

Throughout the negotiations leading to the launch of the Chariot Fund, and its initial operations, neither Chariot Advisors nor Mr. Shifman had an algorithm or model in place capable of conducting the currency trading he described. While Mr. Shifman had discussions with outside sources to obtain such an algorithm or model, he had not selected any particular model. There was no contract to obtain one.

The Order alleges violations of Section 15(c) of the Investment Company Act. That Section requires that the terms of any agreement to serve as an investment adviser of a registered investment company be approved by a majority of the disinterested directors. It also imposes a duty on the directors to request and evaluate such information as may be reasonably necessary for them to evaluate the terms of the agreement. Generally this means that the directors must obtain sufficient information to evaluate the nature, extent and quality of the services to be provided. The Order also alleges violations of Investment Company Act Section 34(b) and Advisers Act Sections 206(2) and 206(4).

Respondents resolved the proceeding. Chariot Advisors consented to the entry of a cease and desist order based on Section 34(b) of the Investment Company Act. Mr. Shifman consented to the entry of a cease and desist order based on Section 206(2) of the Advisers Act and Sections 15(c) and 34(b) of the Investment Company Act. Mr. Shifman also agreed to the entry of an order suspending him from the securities business or participating in any penny stock offering for a period of twelve months. He will pay a penalty of $50,000.



DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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