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Preferred Clients Paid Lower Commissions in Block Trades

 The SEC censured and fined an institutional manager for charging different commission rates to different clients even though the manager combined orders in block trades.  The compliance policies and procedures required that the manager allocate execution costs on a pro rata basis when using block trading.  However, certain client agreements (or instructions) imposed a cap on commission rates.  The SEC alleges that the manager allocated commission rates up to the cap for the preferred clients and then allocated the remaining costs to the other clients, thereby causing them to incur more than their pro rata share.  The SEC charges the manager with failing to follow its own procedures.

Large institutional clients often request special treatment either directly or through “most favored nation” clauses.  Sales folks want to land these relationships and often agree to client requirements without consulting with the compliance team.  As a result, last year’s clients loses out to this year’s prospect.  A fiduciary should treat all its clients equitably. 

State-Registered Adviser Barred and Fined for Cherry-Picking

The SEC fined and barred the principal of a state registered adviser for cherry-picking trades to favor his personal accounts over client accounts.  The adviser used an omnibus account at two different brokerage firms over a 3-year period to engage in day trading.  The SEC asserts that the adviser allocated trades after the relevant security’s intraday price changed.  The SEC maintains that the trading outcomes indicate a statistically significant allocation to personal accounts.  Over the period, the respondent’s first day allocations resulted in 81.9% profitable trades to his personal account but only 16% to client accounts.  The brokerage firms closed his omnibus accounts because they suspected cherry-picking, although they did not inform the respondent why they terminated.  A third brokerage firm did not allow omnibus accounts.

OUR TAKE: State-registered advisers are not subject to SEC exam or the compliance rule (206(4)-7), which requires a compliance program that includes annual testing and reporting.  As a consequence, an adviser that is not SEC registered can go several years engaging in clearly illegal conduct without detection.