SEC Charges Adviser and its COO with Fraud for Orchestrating Sham Cross Trade between Clients

A recent pair of SEC enforcement Orders against registered investment adviser Talimco, LLC and its Chief Operating Officer Grant Rogers highlight the need for advisers to be ever-mindful of their fiduciary duties to both clients when effecting cross trades between such clients.

Cross trading occurs whenever an adviser arranges a securities transaction between two parties, both of whom being advisory clients of the firm. While “principal trading” (where the adviser buys or sells for its own proprietary account) and “agency cross trading” (where the adviser acts as a broker and receives compensation) are accorded heightened scrutiny and require additional disclosures and consents, this recent pair of Orders show that even ordinary cross trades can be highly problematic when one client is favored over another.

In this particular case, the SEC alleges that Talimco and Rogers went so far as to manipulate the auction price of a commercial loan participation in a sham transaction between two of its clients that distinctly advantaged one client over the other.

Talimco had been simultaneously advising a number of collateralized debt obligations (“CDOs”) as well as a private fund, all of which focused on investing in commercial real estate assets. Among those assets held by the CDOs was a $10 million mortgage loan participation relating to a Chicago hotel. After the hotel mortgage loan went into default, Talimco set out to obtain the participation on behalf of its private fund client from the CDO then holding the participation—also a Talimco client. However, as the SEC points out in the Orders, Talimco and Rogers owed the CDO client a fiduciary duty, as its investment adviser and collateral manager, to maximize the price obtained for the participation by identifying willing and able buyers. Instead, Talimco and Rogers served only the interests of its fund client by minimizing the fund’s purchase price through an orchestrated sham transaction meant to satisfy requirements in the selling CDO’s governing documents that an auction be held. Specifically, instead of soliciting bona fide purchasers, Talimco and Rogers sought and obtained a number of dummy bidders to place bids on the assurance that such bids would be too low to win the required auction.

Ultimately, the fund client went on to sell the participation for a significant profit over the price paid to the CDO client, after retaining a third-party consultant to solicit offers from a large number of bona fide bidders. Indeed, prior to this ultimate sale, Rogers made a personal investment into the fund.

The SEC, in turn, found that Talimco and Rogers violated the anti-fraud provisions of the federal Advisers Act, noting in its press release that “by rigging the auction, Talimco and Rogers failed to fulfill their fiduciary duty to their client.” The SEC’s proceedings were settled by the parties with Talimco accepting a censure, disgorgement of $74,000 plus interest, and a $325,000 penalty, and Rogers accepting a one-year securities industry-wide suspension and a $65,000 fine.

While the conduct sanctioned here was more on the egregious side, the lessons for advisers entertaining more mundane cross trades between clients are clear. As the SEC observes in its press release, investment advisers “are expected to have controls in place to detect and disclose conflicts of interest,” further noting that “this action evidences the vigilance of the SEC’s exam and enforcement staff in identifying investment advisers that exploit client relationships and harm investors.”

Accordingly, advisers contemplating cross trades between clients must be cognizant that they have a fiduciary duty to both the buying and selling client, and as such must effectively seek the best price for both clients. This may, in turn, entail extensive valuation analysis, and perhaps independent third-party consulting on the matter. For advisers unwilling to take these extra steps, the choice is clear—forgo the cross trade.

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.

Contact Information