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Trade allocation policies being scrutinized by SEC

Agency seeks to ensure all being treated fairly

Jeremiah Williams
Jeremiah Williams said three cases set the precedent for the SEC to monitor trade allocations.

Large institutional money managers undergoing routine examinations from the Securities and Exchange Commission are now being asked to disclose their trade allocation policies.

The request for disclosure follows recent SEC actions against smaller, retail money managers over charges the firms were, in the agency's terms, “cherry-picking” — giving preferential treatment on trades to clients who pay higher fees to use pooled investments, leading to unfair distribution of trade proceeds.

The concern with institutional managers, sources said, is that asset owners investing through separate accounts might not get the same benefits on trades as investors in mutual funds or other pooled or commingled funds.

“It's not a witch hunt,” said Josh Hall, global head, investment operational due diligence, Willis Towers Watson PLC, New York. “During routine exams, the SEC is asking managers about trade allocation as part of their trading procedures. (The SEC is) trying to see that all clients, whether discretionary or non-discretionary, are being treated fairly.”

SEC officials declined to comment.

Mr. Hall said he's been in contact with “five or six large money managers” that have been asked about allocation policies during a review or expect to be asked when they are reviewed.

“That's how many have either disclosed to us that the SEC has talked with them or asked us for advice on what the SEC might be looking at,” Mr. Hall said.

Mr. Hall would not identify the managers.

For asset owners, fair trade allocation “is a big deal to them,” said Gregg Sommer, Denver-based partner, head of operational risk assessments, at Mercer Sentinel Group. “With RFPs, when we look at managers to run the same allocation, one thing we particularly look at is their trade allocation policies... This is becoming an additional focus (for the SEC). There really are variations in pricing and fees. And there is an opportunity there for those (firms) without the policies or governance structure in place to take advantage of some clients.”

None of more than a dozen money managers contacted for this story would comment on whether they've undergone an SEC review or are scheduled to do so in the near future.

Three money manager officials, who spoke on condition of anonymity, said their trading policies already preclude favoring one group of clients over another, regardless of the fee structure.

Mr. Sommer said most institutional money managers have “finalized, objective trade allocation policies. Most use a pro-rata (proportional) approach across all strategies that allocates average pricing in and out of all accounts.”

Those policies often include stipulations for fair allocation in the event that a trade is skewed, such as when fractional shares are bought or trade flows are issued at the end of the trading day.

Crackdown announced

The SEC announced in 2013 that it would be cracking down on unfair trade allocation — in which proceeds of trades are distributed inequitably. Since then, the agency has filed charges against several firms it accused of cherry-picking, including:

nJ.S. Oliver Capital Management, San Diego, which was fined $15 million in 2013 for allocating more profitable trades to hedge funds in which company founder Ian O. Mausner and his family invested, while doling out less profitable trades to other clients, including a charitable foundation, according to the SEC. The disfavored clients lost $10.7 million.

nMark P. Welhouse, owner of retail money manager Welhouse & Associates Inc., Appleton, Wis., was ordered in June 2015 to repay clients $418,000 for inequitable trade allocation. The SEC said Mr. Welhouse would delay allocation of the trades to either his or his clients' accounts until later in the day after he saw whether the securities appreciated in value.

nWealth manager TPG Advisors, doing business as the Phillips Group, Woodland Hills, Calif., was accused in April by the SEC of having “unfairly and systematically allocated profitable trades to a set of accounts while other accounts were harmed” by unprofitable trade allocation from January 2010 to August 2014. That case remains to be adjudicated by an SEC administrative law judge.

Jeremiah Williams, Washington-based counsel at the law firm of Ropes & Gray LLP and former senior counsel in the SEC's asset management enforcement unit, said that in some cases, the portfolio managers profited directly by investing in the funds in which preferential trading was done, or preferred customers received more trade proceeds than others.

“The distributions were not necessarily made fairly,” he said.

While the three cases did not involve “household names” in money management, Mr. Williams said, it established a precedent under which the SEC would continue to monitor trade allocation policies, possibly by including allocation questions permanently in manager exams.

“Given these cases and that it's clearly a focus of the SEC, it wouldn't surprise me if it were to be part of the exams permanently,” Mr. Williams said. “The SEC has been looking at this for a while. It's not a surprise that they're now including this in general manager reviews.”

Cooperating with SEC

Mr. Hall at Willis Towers Watson said the managers he's spoken with all are cooperating with the SEC.

“It seems to be much more collaborative, to be honest,” Mr. Hall said. “The SEC thinks trades for clients should be executed and e-mail notifications sent at the same time, so these managers have changed their trade allocation policies. There've been no fines, no charges. All are cooperating, and at the end of the day, they're doing what they have to do.”

Mr. Williams said that in cases where money managers have disclosed to clients via side letters that they are giving preferential trading treatment to certain clients and detail the differences, “that could be permissible” by the SEC if all parties agree in advance.

The SEC's review of trade allocation policies would be a “natural evolution” from previous agency reviews of side letters, Mr. Hall added.

Mr. Hall said the trade allocation reviews could lead to some proactive changes in allocation policies at money managers.

“Every manager wants to debate the point” that their current allocation policies are fair, he said. “But I think these are process issues that they want to get over. It might slow their (trading) process down, but I think they'll adapt.”

This article originally appeared in the May 30, 2016 print issue as, "Trade allocation policies being scrutinized by SEC".