Cheri Picking

When the Law Takes a Dim View of Cherry-Picking

Cheri Picking

As the Securities and Exchange Commission admonishes newly-registered investment advisers on its Website, “As an investment adviser, you are a ‘fiduciary’ to your advisory clients. This means that you have a fundamental obligation to act in the best interests of your clients and to provide investment advice in your clients’ best interests. You owe your clients a duty of undivided loyalty and utmost good faith. You should not engage in any activity in conflict with the interest of any client, and you should take steps reasonably necessary to fulfill your obligations.”

Unfortunately, not all investment advisers take the fiduciary obligation seriously. Some make an outright mockery of it such as Noah L. Myers, the sole owner of Middlecove Capital LLC of Essex, Connecticut. Myers pleaded guilty in federal court to defrauding his clients through a “cherry-picking” securities scheme. Here is how it worked: Myers would send in large block trades that would be executed at different prices.  However, rather than allocating those trades fairly among his clients, he gave himself the best prices, leaving the inferior trades for his clients. In a round-trip trade, he was able to buy low and sell high for himself while doing the opposite for his clients. According to the SEC’s indictment, Myers realized ill-gotten gains of approximately $460,000, but his cherry-picking cost his clients more than $2,000,000 in losses. This seems awfully inefficient to us. His clients would have been better off if he had simply embezzled the $460,000. The remaining $1.5 million must have gone to the counterparties in Myers’ trades, perhaps the high-frequency traders discussed by Michael Lewis in Flash Boys.

Myers faces a maximum prison term of 20 years and fine up to $5 million. His sentencing date is set for January 12, 2015. Middlecove Capital is now kaput, and Myers is forever barred from the securities industry. The whistleblowers in this case were his employees who discovered with the help of software that he was allocating trades in a self-dealing manner. U.S. Attorney Deidre Daly said, “investment advisers who breach their clients’ trust in violation of federal securities laws will be prosecuted and risk losing both their freedom and their ill-gotten gains.”

In our opinion, Myers’ behavior is reminiscent of the worst practices of brokers in the nineteenth and early twentieth centuries. As we learned from some of the antique finance books in IFA’s library, it was standard practice for brokers to take client orders and report that their buys executed at the day’s highest price and their sells at the lowest price, pocketing the difference for themselves. Here is one example that exposes the shenanigans that regularly occurred in the San Francisco Stock Exchange in the 1800s. Of course, there is nothing new under the sun. Just a few years ago, Bank of New York Mellon swindled some Virginia pension plans out of $20 million by reporting currency trades at the worst prices of the day, as we discussed in this article.

In our opinion, the lesson for investors is to never stop being vigilant. One essential thing they should demand is transparency. While it is important that their money be held at a reputable institution such as Schwab, Fidelity, or TDAmeritrade, that alone is not enough, as the clients of Middlecove (who had their funds custodied at Schwab) discovered. We are not privy to what Myers told his clients as to why he placed so many trades in their accounts, but we can imagine he laid claim to some proprietary system that was “guaranteed” to eventually make money. Bernie Madoff was also a registered investment advisor who claimed to have a secret sauce for getting consistently high returns without volatility, but he did not use a separate custodian for client funds.

If you believe you have information about an investment fraud, please visit this SEC Webpage

FOLLOW-UP

On January 12th, 2015, Noah L. Myers was sentenced by a federal judge to serve forty months imprisonment, followed by three years of supervised release plus 150 hours of community services. We think he got off easy, and so does one of our readers who contacted us and shared her heartbreaking story about her mother being one of Myers' victims:

"Noah Myers mocked my mother when she questioned him about her losses.  But she was too humiliated to share her concerns about him with her family until it was too late.  She worked hard and lived frugally.  She never took risks.  Above all, she was brought up to respect and trust professionals - doctors, lawyers, teachers, etc. Two months before she died, she learned from the SEC she had been robbed.  She had entrusted Noah Myers with a small nest egg that she wanted to leave to help her children and her grandchildren on in their old age.    In the last week of my mother's life she continued to talk about her decision to stay with Middlecove.  In those precious moments when we should have been talking about happy memories my mother anguished about her 'mistake'.  Myers robbed my mother of more than money.  He robbed my mother of her peace of mind, too."