RIA Compliance Blog
The SEC recently settled cherry-picking charges against a Minnesota investment adviser and its sole owner. North East Asset Management Group and its owner, Gregory Zandlo, settled the Commission’s claims without admitting or denying its findings.
The SEC found that, through his firm, Mr. Zandlo shifted profitable trades to certain accounts from December 2020 through May 2022. Specifically, the SEC claimed the defendants were shifting profitable trades to accounts belonging to the firm, Mr. Zandlo, or people related to Mr. Zandlo (collectively, “Favored Accounts”).
Mr. Zandlo allegedly used his discretionary authority over client trades to aggregate orders on behalf of multiple accounts, otherwise known as block trading. The defendants often placed multiple block orders for the same security on the same day. Key to the SEC’s claim is that Mr. Zandlo and his firm had the opportunity, through their third-party broker, to allocate the shares or sales of that security to each account at an average cost. This would ensure that all accounts paid the same cost and received the same gain. Instead, Mr. Zandlo and his firm would allegedly allocate the more profitable trades to the Favored Accounts, at the expense of their 78 other clients (“Unfavored Accounts”). In short, Mr. Zandlo and his firm specifically favored their accounts over their clients’ instead of treating all accounts equally.
The Commission provides an example: one day, the defendants placed a block purchase order for 1,000 shares of a security. The order was filled and executed at $24.28 per share. Later that day, they placed another order for 1,000 shares of the same security, with a share price of $22.93. At close, the defendants allocated all 1,000 shares priced at $22.93 to Favored Accounts and the 1,000 $24.28 priced shares to Unfavored Accounts.
The SEC also claims that, sometimes, the defendants would make a block purchase, then sell the entire block by day’s end. The defendants would then allocate all the trades’ profits to Favored Accounts.
Procedurally, the SEC faulted the defendants for not implementing policies and procedures regarding block trading. Instead of determining allocations beforehand, without knowing which would be more or less profitable, Mr. Zandlo allocated trades at the end of each business day, creating the opportunity to favor certain accounts over others.
The Commission calculated that $15,485,058 of the defendants’ $18,761,004 of purchased securities, or 82.54%, were block trades. The SEC also calculated the win rate, or percentage of traded dollars with a positive return at the trading day’s end, and the day-one profit rate for the Favored and Unfavored Accounts. The Favored Accounts had a 91.6% win rate and a 2.47% day-one profit rate, resulting in profits of approximately $105,820. The Unfavored Accounts had a 31.3% win rate and a day-one profit rate of -1.01%, resulting in losses of approximately $112,667.
The SEC charged the defendants with willful violation of the antifraud provisions of the Exchange Act (Section 10(b) and Rule 10b-5 thereunder) and the Investment Advisers Act (Sections 206(1) and 206(2)). Mr. Zandlo agreed to pay $80,599 in disgorgement of his ill-gotten gains, $17,172.47 in prejudgment interest, and $141,000 in a civil monetary penalty. North East Asset Management Group agreed to pay $10,609 in disgorgement and $2,260.36 in prejudgment interest. Mr. Zandlo also agreed to be barred from association with any investment adviser, broker, dealer, municipal securities dealer, municipal advisor, transfer agent, or nationally recognized statistical rating organization, and for North East Asset Management Group to be censured.
This case highlights the value of sound policies and procedures for block trading and general execution. As always, it’s important to consult experienced attorneys when acting as an investment adviser.
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.