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SEC Enforcement: RIA Fined for Backtested Data Misuse

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Among recent enforcement actions by the Securities and Exchange Commission were charges against an RIA for misuse of backtested performance data; against a former Goldman Sachs compliance employee for insider trading; charges against two bitcoin mining companies in a Ponzi scheme; and charges against three traders for spoofing and order mismarking.

RIA Fined Over Misuse of Backtested Data

The SEC has charged Alpha Fiduciary Inc., a $737 million registered investment advisor, and its majority owner, president and former chief compliance officer Arthur Doglione, with failing to properly disclose its use of backtested, hypothetical results in marketing materials.

According to the agency, from at least August 2010 to March 2013, AFI, Doglione and the firm’s former business development director created and distributed to clients and prospective clients advertising that did not sufficiently disclose that performance data for the firm’s Global Tactical Multi Asset Class Strategies (GTMACS) was not actual, but instead was backtested and hypothetical.

Although Alpha provided several pieces of performance advertising generally disclosing the use of “certain hypothetical performance and portfolio information,” those disclosures were not direct, were often not on the same page as the hypothetical data and were contrary to other statements that said that GTMACS’ performance data was actual, not hypothetical.

In addition, advertising included examples of favorable investment decisions but failed to mention decisions that didn’t work out so well. The firm also failed to implement adequate written compliance policies and procedures.

AFI and Doglione were censured and subjected to a penalty of $250,000. In addition, the firm was required to hire an independent compliance consultant.

Ex-Goldman Compliance Employee Used Trader Emails to Make Illicit Trades: SEC

Yue Han, a former Goldman Sachs employee, was charged by the SEC with insider trading after the agency said he stole nonpublic information in the firm’s email system so he could trade illegally in advance of client mergers and make more than $450,000 in illicit profits. The SEC also got an emergency freeze order for his assets and the accounts he used to place the trades.

According to the agency, Han, who also goes by the name John Han, worked as an associate in Goldman’s compliance department. He gained access to investment banker emails as part of his work developing surveillance software designed to monitor other employees for potential misconduct, such as insider trading, and then used confidential information he found in emails sent and received by Goldman investment bankers responsible for advising clients on impending merger and acquisition transactions.

Han began working at Goldman in late 2014, and was assigned to a group enhancing the firm’s ability to conduct electronic surveillance of its employees to identify insider trading and other misconduct. As part of his job, Han was given access to the emails of investment banking employees.

Taking advantage of the information he found in these emails, Han bought securities, including out-of-the-money call options, of at least four companies that were on the brink of being acquired: Yodlee Inc., Zulily Inc., Rentrak Corp., and KLA-Tencor Corp. He traded not only in his own account, but also in an account belonging to his father, Wei Han, who lives in China. The elder Han is named as a relief defendant.

The investigation is continuing.

SEC Charges Bitcoin Mining Companies on Ponzi Scheme

The SEC has charged two bitcoin mining companies and their founder with running a Ponzi scheme.

According to the agency, Homero Joshua Garza conducted the fraud through his Connecticut-based companies GAW Miners and ZenMiner by purporting to offer shares of a digital bitcoin mining operation. (“Mining” for bitcoin or other virtual currencies means applying computer power to try to solve complex equations that verify a group of transactions in that virtual currency. The first computer or collection of computers to solve an equation is awarded new units of that virtual currency.)

From August to December 2014, Garza and his companies sold $20 million worth of purported shares in a digital mining contract they called a Hashlet. More than 10,000 investors purchased Hashlets, which were touted as always profitable and never obsolete.

Although Hashlets were depicted in GAW Miners’ marketing materials as a physical product or piece of mining hardware, the promised contract purportedly entitled the investor to control a share of computing power that GAW Miners claimed to own and operate. But GAW Miners and ZenMiner didn’t actually own enough computing power for the mining it promised to conduct.

Investors were misled to believe they would share in returns earned by the bitcoin mining activities, but since the computing capability wasn’t there, GAW Miners directed little or no computing power toward any mining activity.

Because Garza and his companies sold shares in far more computing power than they owned, they owed investors a daily return that was larger than any actual return they were making on their limited mining operations.

Therefore, investors were simply paid back gradually over time under the mantra of “returns” out of funds that Garza and his companies collected from other investors. Most Hashlet investors never recovered the full amount of their investments, and few made a profit.

The SEC seeks permanent injunctive relief as well as the disgorgement of ill-gotten gains plus prejudgment interest and penalties. Three Charged with Fraud by SEC

Twin brothers Behruz and Shahryar Afshar and their friend and former broker Richard Kenny, Chicago-based traders, were charged by the SEC with fraud after they were accused of circumventing market structure rules in a pair of options trading schemes.

According to the agency, the three mismarked option orders to obtain execution priority and lower fees, and engaged in manipulative trading known as “spoofing” to generate liquidity rebates from an options exchange.

Nonbroker-dealers are limited to no more than 390 orders in options per day on average, whether executed or not, lest they be designated “professional” during the next quarter, rather than “customer.”

However, for every quarter from October 2010 to December 2012, the Afshars’ accounts (in the names of Fineline Trading Group LLC and Makino Capital LLC) far exceeded the 390-order threshold. Nonetheless, they were able to continually place “customer” orders throughout this time period by alternating their trading on a quarterly basis between accounts.

The “customer” and “professional” designations are supposed to apply to all accounts beneficially owned by the trader. However, the Afshars and Kenny accomplished this back-and-forth scheme through false representations that Behruz solely owned Fineline and that Shahryar solely owned Makino, despite the fact that Behruz had an ownership interest in both companies.

Then there was the spoofing. From May 2011 to December 2012, that scheme was designed to take advantage of the “maker-taker” program offered by an options exchange, in which an order that is sent to an exchange and executes against a subsequently received order generates a “maker” rebate from the exchange. In contrast, an order that immediately executes against a preexisting order is charged a “take” fee.

The Afshars and Kenny used all-or-none (AON) options orders, hidden orders that must be executed in their entirety or not at all, and placed smaller, non-bona fide displayed orders in the same option series and price as the AON orders, but on the opposite side of the market. The smaller orders were not for execution, but to alter the option’s best bid or offer in order to induce, or spoof, other market participants into placing orders at the same price.

Those orders from other market participants executed against the Afshars’ hidden AON orders, and any open displayed orders were then canceled. Because the executed AON orders existed before the orders sent by the spoofed counterparties, they were deemed to have added liquidity and generated rebates for the accounts of Fineline and Makino.

— Check out SEC Agrees to FINRA’s BrokerCheck Change on Posting Firings on ThinkAdvisor.


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