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News January 26, 2015 Issue

40 Months in Prison Plus $788,000: The Price of Cherry Picking

The short-term gains of cherry picking are simply not worth it, particularly when they bring long time pain in the form of incarceration, a civil money penalty, damaged credibility and a ruined career.

Noah Myers

, former owner of adviser MiddleCove Capital, found this out the hard way. As part of a plea bargain with U.S. Attorney’s Office for the District of Connecticut, he was sentenced January 13 by the U.S. District Court to 40 months imprisonment for allegedly engaging in fraudulent trade allocations – more colloquially known as cherry picking – that resulted in Myers gaining approximately $460,000, and clients losing more than $2 million over a more-than-two-year period.

Separately, the SEC on January 16 settled

with Myers over the same charges. Myers was ordered to pay disgorgement and interest of more than $488,000, and a civil money penalty of $300,000. In addition, he was barred from the securities industry indefinitely.

Cherry picking and the alleged crime

Cherry picking may occur in a number of ways, including when advisers allocate favorable trades to their personal accounts over those of their clients and, according to the SEC, Myers and MiddleCove were doing a lot of this from October 2008 to February 2011.

"Myers executed his cherry picking scheme by unfairly allocating trades that had appreciated in value during the course of the day to his personal and business accounts and allocating trades that had depreciated in value during the day to the accounts of his advisory clients," the SEC said. Most of the securities he traded in involved an inverse and leveraged exchange traded fund, the agency said. Myers ceased his alleged cherry picking when one of his employees threatened to contact the Commission, according to the administrative order instituting the settlement.

The scheme, according to the SEC, went like this: Myers purchased securities in an omnibus account, but delayed allocation of the purchases until later in the day or the next day. The delay allowed him to see whether the securities appreciated in value. "When a security appreciated in value on the day of the purchase, Myers would often sell the security and disproportionately allocate the purchase and the realized day-trading profit to his own accounts or to accounts benefitting himself or his family members," the agency said. "In contrast, for securities that did not appreciate on the day of purchase, Myers would disproportionately allocate these purchases to his clients’ accounts and his clients would hold the positions for more than one day."

"The SEC and criminal authorities did not distinguish the defendants’ favorable allocation of trades from outright theft," said

DLA Piper partner Nicolas Morgan. "This case highlights the need for controls around any omnibus accounts in which an adviser employee has the discretion to allocate trades after the security has changed in value."

The price of non-compliance

In sentencing Myers to 40 months imprisonment, the judge noted

the number of victims who allegedly lost money, the length of time during which the cherry picking took place, and that Myers "has shown a remarkable lack of remorse for conduct that deeply harmed his friends and acquaintances. … Myers largely depicts himself as a victim, not as a perpetrator, which suggests that he has not yet accepted the wrongfulness of his conduct." Myers, once he is released from prison, will then face a supervised release period of three years.

"A court imposing a harsher penalty in light of the defendant’s failure to accept responsibility is a fairly routine issue faced by defendants facing SEC or Justice Department charges," said Morgan. "you can accept responsibility or you can defend yourself, but it’s very difficult to do both."

In the 2002 case of SEC v Lipson

, Morgan said, Judge Richard Posner of the Seventh Circuit highlighted the problem when he said:

"[Lipson] next objects that in imposing the maximum penalty, the district court was influenced by the fact that he steadfastly maintained his innocence and claimed to be the victim of a government vendetta. He says that to allow such factors to influence punishment violates due process of law and the First Amendment to boot. He seems unaware that acceptance of responsibility for illegal conduct is a routine and unexceptionable feature even of criminal, let alone of civil, punishment. The criminal who in the teeth of the evidence insists that he is innocent, that indeed not the victims of his crime but he himself is the injured party, demonstrates by his obduracy the likelihood that he will repeat his crime, and this justifies the imposition of a harsher penalty on him. It makes no difference whether, as in this case, the government is seeking only a civil remedy. The evidence against Lipson was overwhelming, and his insistence in the face of it that he is a shorn sheep argues for heavy punishment to bring him to his senses."

Prior to the judge’s sentencing, Myer’s counsel pleaded

with the judge not to impose such a sentence. His client "was wrong to allocate the losses as he did, but he was not motivated to steal from people and was not motivated simply by greed, as the government suggests. He tried to make the losses back for his clients through other trades. He was not a scam artist that planned to disappear after taking people’s money. He was a person who wanted to have a life as a trader."

Myers "failed to keep sight of what is right and wrong during a very stressful time in his life," his attorney said. "As a result, he has lost his career, has been publicly shamed, lost everything of value that he owned, and on top of it all will owe more than $800,000 [including ongoing interest] per the SEC order."

The cherries are discovered

Charles Schwab & Co.

, which served as the custodian for all of MiddleCove’s accounts, in November 2010 notified a MiddleCove employee after one of its internal programs flagged Myers’ accounts as "potentially receiving favorable allocation of profitable day trades," the SEC said, leading the MiddleCove employee to investigate Myers’ trading patterns. Based on that review, the employee believed that Myers was allocating trades that lost money at the end of the day to clients instead of himself and that performance for Myers’ accounts was much more profitable than his clients’ accounts."

Four Middlecove employees then confronted Myers about a specific trade allocation in mid-December 2010, the SEC said. As a result of the meeting, Myers agreed to use a trading method that required him to place all of his client trades through a certain Charles Schwab trade application, and to use a different method for his own trades, according to the administrative order.

But on February 18, 2011, the problem was identified again. The same Middlecove employee who analyzed Myers’ trading after being notified by Charles Schwab now found that Myers had allocated a day trade profit to himself using a Charles Schwab application that Myers had agreed to use only for client trades. "The employee confronted Myers and threatened to report Myers to the Commission if he did not reallocate the trade to a client," the SEC said. "After this confrontation, Myers stopped cherry picking and did relatively little trading in his own accounts."

SEC examiners then got involved, interviewing Myers in November 2011 about his personal securities trading. "Myers admitted that he had a day-trading strategy in one of his personal accounts that was profitable about 95 percent of the time, but he did not offer a plausible explanation for his stellar day-trading performance."

Disclosure issues

It may come as no surprise that Myers did not disclose his alleged cherry picking, but the SEC nonetheless alleged in its administrative order that "neither Myers nor Middlecove disclosed to clients that they were engaged in cherry picking." Specifically, Myers listed items in MiddleCove’s Form ADV that were "misleading because the statements conveyed the impression that batched trades would be allocated fairly and not unduly favor Myers or MiddleCove" and that for trades including certain kinds of securities, there would be an extra layer of protection provided by a regulatory framework.


Myers and MiddleCove were charged with willfully violating Section 10(b) of the Exchange Act and its Rule 10b-5, which outlaw fraud, by "knowingly or recklessly allocating profitable trades to Myers’ personal and business accounts at the expense of advisory clients." They were also charged with willfully violating Sections 206(1) and (2) of the Advisers Act, which prohibit fraudulent conduct by an adviser, because of their alleged cherry picking. Finally, Myers and MiddleCove were charged with violating Section 207 of the Advisers Act for filing allegedly misleading Forms ADV. The attorney representing Myers did not respond to a voice mail or email seeking comment.