An irreverent Wall Street Blog

RIA Cherry Picking Case Rings Alarm (Anyone Listening?)

September 15, 2017

You live in an expensive condo apartment building. They put in smoke alarms. They put in fire alarms. They got a full-time guy on duty 24/7 just to watch over everything. One night, all the alarms go off. A fire has started and is beginning to spread. You don't do anything because, well, because it's just an alarm. They go off when someone cooks a steak next door. The guy on duty re-sets the alarms because he doesn't actually smell any smoke or see any fire and there's a big game on and he's watching it on his iPad, which he's not supposed to be doing, but the job doesn't pay all that much and like who the hell's gonna know? 

All of which leads us to a recent SEC settlement involving an investment adviser who kept a lot of good trades for himself and dumped a lot of his goofs into the unknowing accounts of his customers. Which bothered his custodian enough to send him packing. But it didn't bother another custodian enough to offer him refuge. And it didn't seem to bother the industry's regulators for about five years.

Case In Point

Jeremy A. Licht is the founder, principal, chief compliance officer, and sole owner of JL Capital Management, a sole proprietorship registered investment adviser ("RIA"). In the course of trading for the accounts of his clients, Licht also traded for his personal accounts -- a not uncommon practice in the industry. Licht's customer and personal accounts were handled by a custodian, which was a registered broker dealer.Unfortunately for Licht, the Securities and Exchange Commission ("SEC") wasn't thrilled with certain aspects of his trading practices. Pointedly, the SEC alleged that from at least January 2011 through November 2015, Licht realized at least $88,504 in ill-gotten gains by "cherry picking" certain favorable trades to his own account while allocating certain unfavorable trades to the accounts of his clients. In anticipation of the institution of proceedings by the Securities and Exchange Commission ("SEC") but without admitting or denying the findings, Jeremy A. Licht d/b/a JL Capital Management submitted an Offer of Settlement, which the federal regulator accepted. In the Matter of Jeremy A. Licht d/b/a JL Capital Management, Respondent (Order Instituting Administrative And Cease-And-Desist Proceedings, Making Findings, And Imposing Remedial Sanctions And A Cease-And-Desist Order; '34 Act Rel. No. 81584; Invest. Adv. Act Rel. No. 4767; Invest. Co. Act Rel. No. 32815; Admin. Proc. File No. 3-18171 / September 12, 2017) (the "OIP"). 

The OIP is a very well-crafted document and I have opted to cite to the quoted pertinent paragraphs below rather than offer an unnecessary rewording. Note that curing the relevant times the custodians were "Broker 1" from approximately January 2011 to September 2012; and "Broker 2" from approximately October 2012 to March 2016. :

4. Licht submitted trades and allocated them using an online platform provided by a brokerage. He carried out his fraudulent scheme by trading in an omnibus account and delaying allocation of those trades to a specific account until he had an opportunity to observe the security's intraday performance. In many cases, when the price of a stock rose on the purchase date, Licht sold the security the same day, locking in a day-trading profit that he allocated to himself. By contrast, Licht disproportionately allocated purchases that were not profitable on the purchase date to clients. Licht often waited several hours and/or until after the close of the trading day to allocate trades from his omnibus account.

5. Licht's cherry-picking financially benefitted him and disadvantaged his clients. Between January 2011 and September 2012, when Licht's personal and client accounts were custodied at Broker 1, Licht's total first-day profits (realized and unrealized) were at least $35,933, representing a 1.01% return on his investment. In contrast, Licht's clients suffered aggregate unrealized first-day losses of $77,700, representing a -2.15% return. Then, from October 2012 to March 2016, when Licht's managed accounts were custodied at Broker 2, Licht's total first-day profit (realized and unrealized) was at least $52,731, or a 2.07% return on his investment, while his clients had aggregate unrealized first-day losses of $72,816, or a -1.06% return.

6. The difference between Licht's first-day returns and that of his clients is statistically significant. The probability that the disproportionate allocation of favorable trades to Licht at Broker 1 was due to random chance is less than one in a trillion. The probability that the disproportionate allocation of trades at Broker 2 was attributable to random chance is less than one in a million.

7. Since January 2012, Licht reaped at least $88,504 in ill-gotten gains from his cherry-picking scheme.

8. Both Broker 1 and Broker 2 terminated their relationships with Licht because they suspected that he was improperly allocating trades on their platforms. Broker 1 terminated the relationship in August 2012 (effective October 2012), and Licht moved his business to Broker 2's platform, where he continued cherry-picking profitable trades for his own account to his clients' detriment for another three years. Broker 2 terminated its relationship with Licht in January 2016. Licht never informed his clients that the two firms had unilaterally terminated him, nor did he disclose the reason why the brokerages ended their relationship with him.

9. Licht made false statements to his clients in his Forms ADV. In particular, Licht's Forms ADV Part 2A falsely stated that "[n]o Client/investor, account or fund will be favored over any other Client/investor, account or fund as the result of the allocation" of block orders. It also represented that Licht reviewed all personal trading to ensure "that clients of the firm receive preferential treatment." These statements were false and misleading because Licht allocated trades in a manner that favored his personal account and disadvantaged clients.

10. Licht's Forms ADV also represented that "[p]re-allocation statement(s) specifying the participating Client/investor accounts and the proposed method to allocate the order among the clients/investors, accounts or funds are required prior to any allocated order" and that "[a]ggregated orders filled in their entirety shall be allocated among clients/investors, accounts or funds in accordance with an allocation statement created prior to the execution of the transaction(s)." These statements were false and misleading because Licht did not create or employ pre-allocation statements.  

The SEC deemed Licht's allegedly knowing and reckless allocation scheme to constituting a willful violation of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and Sections 206(1) and 206(2) of the Advisers Act. In accordance with the terms of the settlement, the SEC ordered  that he cease and desist from future violations of securities laws, pay $88,504 disgorgement plus $8,714.34 in prejudgment interest and $181,071 in a civil money penalty. Further, the SEC ordered Licht:
  • barred from association with any broker, dealer, investment adviser, municipal securities dealer, municipal advisor, transfer agent, or nationally recognized statistical rating organization; and 
  • prohibited from serving or acting as an employee, officer, director, member of an advisory board, investment adviser or depositor of, or principal underwriter for, a registered investment company or affiliated person of such investment adviser, depositor, or principal underwriter.
Bill Singer's Comment

So much for the fiduciary standard. Licht offers a chilling glimpse behind the curtains, which RIA clients should find as a sobering warning that the conflicts and compromises in the broker-dealer arena are not always eliminated in the RIA arena. Now that you know about cherry picking, don't be so shy about asking your RIA to explain its trading allocation policies and don't be too intimidated to challenge any trades that raise questions. 

The good news from the OIP is that we get a sense that the SEC is doing its job. This settlement sends yet another warning to the industry about parsing through a day's trades and allocating the juicy, sweet cherries of profitable trades to your personal accounts and sticking the sour cherries with the mold on them into your customers' accounts. I say "yet another warning" because we've have several of these in recent years. It's good for the SEC to publish these settlements because they remind the RIA community that it can't hide behind its authorized use of "discretion." Further, this settlement and others is a wake-up call to those who view the omnibus trading account as something akin to a rainy-day piggy-bank. Regardless of how clever you are in hiding your cherry picking, keep in mind that the SEC ferreted out the fraud in Licht (and other cases), so maybe you're not as clever as you think and maybe the regulators aren't as stupid as you had supposed. Someone did indeed ring the alarm!


On the other hand, certain revelations in Licht don't exactly instill confidence in Wall Street's compliance and regulatory regimes. For example, consider this:

8. Both Broker 1 and Broker 2 terminated their relationships with Licht because they suspected that he was improperly allocating trades on their platforms. Broker 1 terminated the relationship in August 2012 (effective October 2012), and Licht moved his business to Broker 2's platform, where he continued cherry-picking profitable trades for his own account to his clients' detriment for another three years. Broker 2 terminated its relationship with Licht in January 2016. Licht never informed his clients that the two firms had unilaterally terminated him, nor did he disclose the reason why the brokerages ended their relationship with him.

As early as August 2012, some five years before the Licht SEC settlement, Broker 1 had terminated its relationship with Licht. According to the OIP, Broker 1 fired its customer because it had determined that Licht was "improperly allocating trades." In terms of Broker 1's compliance oversight, bravo! In terms of the effectiveness of that custodian having sounded the alarm? Not so bravo. Consider that Licht simply moved his cherry-picking to Broker 2. What the hell? Didn't any regulator look into the circumstances prompting the change of custodians? Look into as in any time from August 2012? Y'all know that this case settled in September 2017 right? Did anyone ring an alarm? Did anyone hear an alarm? Consider some of my questions below:

  • Did Custodian Broker 2 inquire as to the circumstances of Broker 1's severance of its prior relationship with Licht? 
  • Given the compliance/regulatory misconduct inherent in cherry-picking, was there any report generated by Broker 1 that put Broker 2 on notice and also put Wall Street's regulatory community on notice? 
  • Did any regulator conduct any inquiry of Licht following his August 2012 termination by custodian Broker 1? 
  • Did any regulator note the glaring omission in Licht's customer disclosure documents about the reason for Broker 1's termination of his relationship?

Permalink

Search BrokeAndBroker

Related Topics

Previous Entries

No Headlines Found

Tag Cloud

Bill Singer BrokeAndBroker FINRA Arbitration AWC SEC BrokerAndBroker Expungement Guest Blog Guest Blogger Aegis Frumento OBA Wells Fargo U5 BrokeAndBroker CRD InSecurities OHO Email Morgan Stanley Defamation U4 NAC ALJ Merrill Lynch BrokerCheck PST Supervision Whistleblower Statutory Disqualification Securities Industry Commentator Rule 3270 Suitability DOJ SDNY Promissory Note Rule 2080 Elderly Rule 2010 Willful WSP OIP Form U4 Wire Fraud Pro Se Rule 8210 EFL UBS Expenses RIA Form U5 Dodd Frank Stephen Kohn Business Expenses TRO Discretion Rule 1122 Bar Willfulness IRS Bank JP Morgan Fraud Discovery Wife Trump Ameriprise Husband NASD Bill SInger FAA Rule 3240 Borrowing Small Firm Conversion Supreme Court Rule 3280 Crypto Edward Jones Margin Wrongful Termination IRA Raymond James CCO Insurance 2Cir Estate Frumento Corrective Action Statement Outside Business Activities Stay Rule 12206 Mail Fraud Schwab arbitration Punitive Damages Tax LPL Promissory Notes Customer Bankruptcy Beneficiary Explained Decision TD Ameritrade Felony COVID Remand Citigroup Motion to Dismiss Options BrokeAndBroker.com Commissions Settlement Trust Case In Point OWB Injunction CFTC ACQ Board DCCir Rule 4511 OTR Initial Decision Retaliation Blockchain Sanctions Rule 3040 Tax Liens Ponzi Rule 2510 Wall Street Motion to Vacate Burris Due Diligence Forgery Spouses 9Cir Rule 4530 Discrimination Jurisdiction Eligibility Rule Unauthorized Discretion Reg SP Personal Expenses Unsuitability Offer of Settlement Rule 12200 Solicitation Outside Business Activity FBI Mandatory Arbitration SRO Insider Trading Bank of America Rule 3010 Compliance Failure to Supervise Checks NYSE Barclays Annuities Manifest Disregard ETF CRS Goldman Sachs Private Securities Transaction Divorce Disgorgement Loan Dissent FINRA Board Rule 3110 10Cir Class Action Cease And Desist PCAOB Fiduciary Conspiracy email Trustee Board of Governors Impersonation Power of Attorney Reimbursement Rule 9552 Credit Card IAR expungement VA Broker Protocol Unfair Competition Spoofing Spouse Cryptocurrency Customer Complaint Liens AML Zipper Emails Annuity Away Account T&P Tax Lien JPMorgan Complaint Indemnification Retirement Wey Disclosure Lucia SDFL Kokesh Due Process POA BD Breach of Contract Appeal MC-400 4Cir Lien Bitcoin Rule 12904 Willfully Coronavirus Public Interest Unauthorized Trading Postponement Racism BOP Severance REIT 3Cir Indictment Elder Abuse Securities Fraud Vacatur Fees Antitrust HFT Brummer Exhaustion of Administrative Remedies Dakota Securities Rule 12805 CMA Net Capital Test Motion to Confirm Rule 2111 Signature Covid Hilton Weiner Whistleblowers Wire Rule 3050 WSPs insecurities guest blogger guest blog aegis frumento Rule 2150 Employment Sexism Whistleblowing Statute of Limitations Marijuana PNC RR Suspension Gensler NASDAQ Deceased Widow Private Securities Transactions Examination Bureau of Prisons Money Laundering OIG BrokeAndBroker.com Blog Robinhood Stifel Nicolaus Sanction Guidelines Deutsche Bank PIABA Loans Bonus Rule 2081 Apple Stifel Signatures DNJ Non Solicitation Audit Will DOL Puts Bonds Leggett Puerto Rico Rule 13200 Preliminary Injunction Confidential Information Enforcement 11Cir Botkin Rule 4513 Misdemeanor Charles Schwab Self Regulation Great Recession OSHA Elder Fraud Mortgage TOD Absolute Immunity JPMS Margin Call Unjust Enrichment Mutual Funds CPA Membership Continuance Credit Suisse Statutory Disqualification Committee Hacking Registration Commission Unsuitable Small Firm Governor NoCA Website Rationale Diversity 1Cir supervision NDCA TheBlot Exam Pennystocks Standing Appointments Clause Arbitraiton Undisclosed Settlement ADA JPM Test Center Passcode BrokeAndbroker Inability to Pay RBC money laundering Mother IPO Finra Election Away Accounts Scottrade Immunity Rule 2210 Testimony Real Estate Robert Cook Annual Compliance Questionnaire AAA TCR Feigenbaum Spoliation Cannabis Statement of Corrective Action WB-APP Rule 13805 Waiver 6Cir Trade Secrets Written Supervisory Procedures 9/11 securities industry commentator State Actor E*Trade Rule 12504 Concentration Reg S-P Bandimere BrokeandBroker Extraordinary Cooperation Rule 9554 CEO Excessive Trading Sexist Affiliate Variable Annuities Michael King Biden Variable Annuity Hurry Sarbanes Oxley Form ADV brokeandbroker FINOP Compensation Imposter Michael King Associates Tortious Interference Solicited Irreparable Harm Restitution Johnny Burris Newman Superior Court FMLA Unsolicited DMD NRF Wachovia Facebook Star Wars Series 7 Medical Condition BrokeAndBroker Bill Singer FINRA Small Firm Rule 12212 Termination Fidelity Hester Peirce DDC Churning Conflict of Interest EDNY Ethereum Administrative Remedies Circuit Court Taxes Confidentiality Trading Platform Customer Information Non-Solicitation Subpoena Default Motion to Compel Sharemaster Financial Professionals Coalition Beneficiaries Research Sexual Discrimination ICO Talman Harris High Frequency Trading Pennystock Self Reporting Constitution Continuing Education Life Insurance Scottsdale 10b-5 Customers McDuff Self Directed PAQ Kon Social Media Marines Vietnam Marine Corps Honorarium Whitman Relevant Disciplinary History Consent Order Ride the Thunder Employment Agreement VIX IM Mutual Fund Service Hugh Hewitt Funds Rule 3030 Wanger Extraordinary Circumstances Stipulated Award Internet Rule 3310 Flash Crash Boycott Saad RMBS Hearing Sexual Harassment Government Accountability Project Information NSF SunTrust Cheating Check Kiting Guitron Obstruction RICO Lawyers Debit Card Wedbush Yesenia Guitron Testing ATM 5Cir Probate Respondeat Superior Privilege FNMA FINRA AWC Private Placement Dementia Scholander Interactive Brokers FOCUS Layering Nondisclosure Annual Audit Falsification 17a-5 Check JP Morgan Securities Guest Bloggers EEOC Lawyer Morgan Stanely Federal Reserve Chevron Son Revocation Capital Gains securities fraud Conflict SP Pension Prudential Oral Discretion Shah Gilani Slander Charity Penalty OWWP Hedge Fund Confirm Disciplinary History wire fraud Attorneys Fees WBAPP GameStop mail fraud Amazon Client Information Gamification Regulation SP Outside Counsel Fiduciary Duty Rory Flynn Acosta DCO Rule 1210 Blackbook Forex Executor Relevant Transamerica Liquidation NY Life Res Judicata Offset Puerto Rico Bonds Permanent Bar ARS Form TCR CDO SD FCI Rule 13504 Death Peirce ACH Joint Account Over Concentration WhatsApp Tesla FCI Beaumont FAP Zoom Texting Newport Coast Securities LLC Jennifer Tarr Obstruction of Justice Christian Stanley Rule 21F Arbitration Civil Rights Unauthorized Practice of Law Taft Correctional Institution Cold Spring Advisory Group Reverse Life Insurance Lehman Third Party Vendor Deferred Compensation Bear Stearns Oppenheimer Rule 13104 MSSB Elder Law 40 Act Withdrawals Rule 2430 Expert Witness Leveraged ETF Google OCIE Crime Embezzlement Control Person Non Solicit Securities America Libel Pruco Time And Price Commodities Fraud Verbal Discretion For Cause Book of Business First Amendment fraud NYG Capital Turnover EDPA bill singer Counterclaim Subject Matter Jurisdiction Tennis Court Mistake Trade Practices Oilpro Charge Rule 13904 Rule 12104 Calls Cantor Fitzgerald Allocation Compliance Questionnaire Trading Jay Clayton Retired Woman With Cane 10b-10 Constructive Discharge Rule 3210 Johnson Purshe Kaplan DAO Powell wrongful termination AWC. FINRA FINRA Arbitration Teleconference Finder\'s Fee Rule 12203 Hotel Jarkesy Nationwide ESOP Kierkegaard Motion Reason for Termination LIBOR AXA YouTube Administrative Process SDOH Non-Disclosure ESG CE Fernandez Trader Tax Advice Pham Panama Telephone Vungarala Cherry Picking Expulsion Lorenzo Nicolas Corcione Fundacion Nicor Ten Commandments Credit Cards SDCA Retroactive Bar Collateral Bar Municipal Advisor Fine Financial Disclosure Retroactive Pershing GME FNI Media sexism NRSRO DRS NFT Section 1332 Exception Reports Schottenstein Bartko FINRA Foundation Negligence Private Placements ALJ Grimes Third Party Beneficiary Transparency JOBS Act Last Known Address QuadrigaCX Mantar GAP Rule 21F-17 In House Counsel CD NYAG Communications Undertaking expenses Promoter SLUSA Accounting JAMS In Connection With Deceased Customer MAP reimbursement TSSB HSBC false statements AMC Rule 13206 Reg SHO DMCA Gross Ruder Task Force Confidential Audit Committee Sharing Agreement Books and Records Kiting Rule 144 VXX Corporate Governance Motion to Compel Arbitration Back Dated Equity ACT! Tysk Altered Apartment Particularity Declaratory Judgment Rule 13212 Lek Rule 13201 Ethics Court of Appeal Orders Daspin Rule 2140 APA Title VII Motion to Exclude Section 206 PSRO Joint Production Discharge Exception Report Salman Stephen A. Kohn Self Regulatory Organization Investment Advisers Act Kent Transitional Bonus UIT MSPB Ruemmler Production Bonus Burden of Proof Notice Alcoholism Jury Instructions Harris finra Confirmation NPI Sterne Agee ALJ Foelak NMS Covid-19 Shotgun Pleading Risk Romer Article V Motiion to Acquit Fraudulent Inducement Grievance LOA annuities Wires Crowdfunding Hacker Confidential Customer Information defamation Rule 12511 Bob Dylan Data Meals Office of Special Counsel Escrow Clearing Firm Bill singer Unauthorized Trades Stipulation Reasonable SIFMA S&P Microcap elderly Motion to Postpone Electronic Communications Fidelity Brokerage Services Public Arbitrator Dostoevsky Bezos Municipal Bonds Berthel Fisher ETFs Expert EDVA FOREX Currency CNBC Income Capitalism No Show Series 79 Guardian Punitive Cryptocurrencies PN Exotic ETF Clayton Lexicon Reg D Ecuador Production Hayden Newbridge MDLA Daughter Witness Tampering JPMorgan Chase NYLIFE Non-Solicit Rule 420 Voya Principal Quasi Governmental Exemption Non Compete College Solomon Day Trading Disability Regulation Elon Musk Restaurant Private Actor Disparate Treatment Abstention AI Chief Compliance Officer Willfull Nietzsche Bequest Rule 2330 Rule 9216 Unregistered Fee Conflicts Rule 1031 Game of Thrones whistleblower Initials Perjury Investment Adviser Howey Harassment Vaccarelli Led Zeppelin Broke And Broker Judgments Traders Exhaustion Doctrine SIE Success Fee TradeStation ADR