On July 31, 2020, the Securities and Exchange Commission (“SEC”) announced it was charging Connecticut-based investment adviser, Birinyi Associates, Inc. (“BA” or the “Firm”), with violations of Sections 206(2) and 206(4) and Rule 206(4)-7 thereunder (“the Compliance Rule”) of the Investment Advisers Act of 1940 (“Advisers Act”).
The order cites BA with engaging in unfair trade practices by allocating certain trades to accounts for clients in a short-term day-trading strategy while the majority of the Firm’s clients were in a long-term buy-and-hold strategy, subsequently placing the buy-and-hold clients at a disadvantage and contradicting the Firm’s disclosures and internal policies.
Additionally, the Firm failed to maintain trade allocation policies and procedures reasonably designed to prevent unfair trade allocation practices.
Without accepting or denying the charges, BA agreed to cease-and-desist orders, censure, and to pay a $100,000 penalty. Furthermore, BA is required to comply with specified tasks outlined in the order, including the retention of an independent compliance consultant.
Background on the SEC’s Order
The order describes how BA engaged in unfair trade allocation practices from June 2014 to June 2019, wherein the Firm allocated profitable trades to certain clients in the Firm’s day-trading strategy and subsequently placed buy-and-hold clients at a disadvantage.
The order describes how BA made block trades in a master account and then allocated the purchase and sale of the securities to client accounts from the master account. BA would allocate the purchase and sale of a security to a day-trading client, rather than allocate the purchase of that same security to a buy-and-hold client account per the Firm’s disclosures and internal policies.
By engaging in this practice, BA failed to consider that the day-trading clients were receiving profitable risk-free trades while buy-and-hold clients were assuming all of the risks on behalf of the day-trading clients.
Furthermore, the Firm’s compliance policies and procedures failed to contemplate how to determine which day-trading client account received a profitable trade; how to allocate the trades fairly between the day-trading clients and buy-and-hold clients; and, how to ensure the Firm was not violating the Advisers Act in the process.
What Should I Consider When Evaluating My Firm’s Trade Allocation Policies and Procedures?
When reviewing your trade allocation policies and procedures, you should consider a number of important areas including timing considerations, allocation of bunched trades, factors to consider in adjusting allocations, and purchase in new and secondary offerings.
Furthermore, as you think about policies related to the allocation of your firm’s bunched trades, consider whether they contemplate fully executed trades, partially executed trades, additional trades in the same security on the same day, trade reconciliations, and trade breaks. When considering factors for adjusting allocations, ensure that your firm includes steps for deminimis allocations, cash needs due to withdrawals, and account objectives and guidelines. Moreover, you should ensure that your firm is taking all necessary steps to consistently document its compliance with its allocation policies and procedures including periodic testing.
Last, and definitely not least, make sure that you review the disclosures in your Form ADV to ensure that they are consistent with your policies and procedures and actual practices. As outlined in the SEC’s order against BA, disclosures that are inconsistent with your firm’s actual practices can be considered misleading and a potential violation of the Advisers Act.
Should you or your firm have questions regarding how to address concerns around your trade allocation practices; updates to your trade allocation policies and procedures and disclosures in your Form ADV; and/or, how best to test your trade allocation policies and procedures, please contact us at (619) 278-0020 to schedule a consultation. Our compliance experts are standing by to help you.