RIA Compliance Blog
On January 25, 2017, the Securities and Exchange Commission (“SEC”) filed a complaint in the District Court for the District of Massachusetts (“District Court”) against Strategic Capital Management, LLC (“SCM”), an investment advisory firm, and its owner, Michael J. Breton. The complaint alleges that Breton, through SCM, garnered about $1.3 million by defrauding clients using what is known as a “cherry-picking” scheme. The action follows a similar action brought by the SEC last October.
According to the SEC, cherry-picking occurs when an investment adviser “defrauds clients by purchasing stock and then waiting to see if the stock price goes up, or down, before deciding whether to keep the trades… or to put the trades into clients’ accounts.” Cherry-picking typically involves the investment adviser allocating more profitable trades to its own accounts and allocating less profitable ones to client accounts. It is a breach of fiduciary duty because it entails an investment adviser placing its interests above those of its clients.
The SEC’s complaint alleges that from about January 2010 through August 2016, Breton and SCM were investment advisers to numerous client accounts. Breton, through SCM, bought public companies’ securities using a block trading omnibus account known as a “Master Account.” Through this Master Account, Breton was permitted to make orders for both his personal accounts and his clients’ accounts.
The complaint also claims that once Breton bought the public companies’ securities, he delayed apportioning the securities until after the companies that had issued the securities released their earnings announcements. Once that happened, Breton covertly apportioned profitable trades to his own accounts and apportioned less profitable ones to client accounts.
The SEC’s complaint also alleges that Breton and SCM “made false and misleading statements and failed to disclose material facts to SCM’s clients.” For example, evidence shows that SCM’s Form ADV Part 2 from August 2010 stated that Breton would not carry out transactions for his benefit that would place SCM’s clients in an unfavorable position, when in fact he did. The complaint also claims that SCM’s Forms ADV Part 2 from 2011, 2012, 2013, 2014, 2015, and 2016 contained disclosures that were untrue. Specifically, the Forms ADV assured clients that SCM recognized the fact that it owed a duty of loyalty to clients and that neither SCM, its principals, nor its employees would place their financial affairs above those of their clients. However, evidence indicates that Breton, through SCM, was involved in a cherry-picking scheme, which would involve Breton prioritizing his financial interests over those of his clients. As a result, the statements made in the Forms ADV were rendered misleading.
The SEC’s complaint seeks the following forms of relief against Breton and SCM. First, the SEC requests that the District Court issue permanent injunctions against Breton, SCM, and anyone associated with them from continuing to defraud clients through use of cherry-picking. The SEC also asks that the District Court order Breton and SCM to disgorge any “ill-gotten gains and losses avoided.” Finally, the complaint requests that the District Court order Breton and SCM to pay civil monetary penalties.
Parker MacIntyre provides legal and compliance services to investment advisers, broker-dealers, registered representatives, hedge funds, and issuers of securities, among others. Our regulatory practice group assists financial service providers with complex issues that arise in the course of their business, including compliance with federal and state laws and rules. Please visit our website for more information.