Cherry-Picking

Portfolio manager Isolde Ferrante places block trades each morning in an omnibus account and does not assign the fills to specific accounts until late afternoon, after she can see which positions moved favorably. Winners consistently land in her firm's proprietary account and losers in client accounts. This practice is best described as:

1. A.Cherry-picking, a fraudulent allocation practice and a breach of the duty of loyaltyCorrect. Delaying allocation until results are known and steering winners to the firm is cherry-picking.
2. B.Churning, because the block trading generates excessive commissionsChurning concerns excessive trading volume in a client account, not the assignment of fills.
3. C.A permissible use of an omnibus account, since every client received an execution at the block priceA uniform price does not cure a biased assignment of which accounts get which trades.
4. D.Front running, because the firm's account traded alongside client ordersFront running means trading ahead of a known client order; here the trades are simultaneous and the abuse is in allocation.

Why: Cherry-picking is the fraudulent post-trade allocation of profitable trades to favored accounts and unprofitable trades to disfavored ones, made possible by delaying allocation until outcomes are known. It is remedied by making a written allocation determination at or before order entry, so the assignment cannot depend on the result. Cherry-picking is a breach of the duty of loyalty and is charged as fraud.

Bruckner Ridge Advisers aggregates client orders into a single block. The block fills only partially, and the firm assigns the best-priced fills to the principal's personal account and the remainder to clients. This practice is:

1. A.Permitted, because the firm's brochure states that the adviser and its personnel may participate in aggregated ordersDisclosing that the adviser may participate in blocks tells clients nothing about receiving the worse half of every fill. General disclosure of participation does not authorize preferential allocation of the results.
2. B.Prohibited, because allocating the most favorable fills after the outcome is known places the adviser's interest ahead of clientsFills must be allocated under a policy fixed before execution, ordinarily pro rata, precisely so the adviser cannot use hindsight to route better prices to itself. Choosing after the fact is a breach of the duty of loyalty.
3. C.Permitted, because the adviser's personal account is charged the same commission rate as the client accountsEqual commissions address one dimension of fairness while leaving the actual harm untouched. The clients are injured through execution price, not through the commission schedule.
4. D.Permitted, because clients still received execution prices better than the day's volume-weighted average priceComparing client fills to a market benchmark measures the wrong thing. Clients were entitled to their pro rata share of the block actually obtained, and a favorable benchmark does not restore what was diverted.

Why: Allocating the most favorable fills to the adviser's own account after seeing the results is cherry-picking, a direct breach of the duty of loyalty. An adviser that aggregates orders must allocate fills according to a written policy established before the outcome is known, ordinarily pro rata, so that the allocation decision cannot be influenced by which account benefits.