The Securities and Exchange Commission has sued a Glenn Cove, N.Y., investment adviser with for allegedly defrauding his customers a total of $8 million. This was done, the SEC said, in a cash investment program in which the adviser inflated the value of customer holdings through a practice called cross-trading.
The adviser, Warren Nadel, was able to get away with his scam from early 2007 through 2009, according to the SEC, because he owned the brokerage firm which acted as the agent to the buyer and seller of the securities. Nadel could not be reached for comment.
Nadel, according to the SEC, also sent his clients fraudulent trade confirmations which erroneously indicated that Nadel executed trades on the open market when in fact he traded between advisory client accounts he controlled.
The confirmations indicated that Nadel’s brokerage firm called WDNC acted as the clients’ agent in over-the-counter transactions when in fact it acted as a principal. The confirmations did show that the counterparties were customers of WDNC but did not indicate that they were also advisory clients of Nadel.
Surprisingly, Nadel, who also served as the chief compliance officer for his brokerage firm, did use a third-party clearing firm. The SEC never identified the firm and did not indicate whether the clearing firm caught onto Nadel’s scam.
“Had Nadel properly disclosed the nature of each cross-trade and sought client consent, clients would have learned that this supposedly conservative short-term and liquid cash management investment strategy was essentially a sham because there was, in fact, no liquid market for most of these securities at the reported prices, and actual market prices, as reflected in actual market transactions, were in most instances significantly less than the prices defendants were claiming,” wrote the SEC which sued Nadel in a Manhattan court.
The documentation dated January 13 indicated that the SEC wants a jury trial, disgorgement of the profits, a civil penalty and an injunction preventing Nadel from “further violations of anti-fraud regulations.” Richard Primoff, an SEC attorney prosecuting the case in the U.S District Court for the Eastern District of New York, said that a court date has not been set and would not give any indication on the value of the disgorgement or civil penalty.
According to the SEC’s complaint, the goal of the so-called liquid cash investment program was to have customers buy and sell preferred utility stocks traded either over-the-counter or on exchanges such as the New York Stock Exchange, AMEX and Nasdaq and hold them for short periods of time to generate either dividend income or capital appreciation.
In exchange, the clients were required to pay trading commissions and investment management fees which amounted to over $8 million. Of that amount more than $6 million came from commission and at least $2.4 million came from advisory fees.
However, about 90 percent of at least 11,250 trades --were not executed on the open market. By shuffling securities back and forth between advisory accounts at inflated prices, the SEC said, Nadel created the false impression that there was a liquid market for these securities and the market prices for the securities were consistent with the inflated values reported.
Cross-trading is legal except for funds which fall under the guidelines of the Employee Retirement Income Security Act of 1974; those are typically employee pension plans. T
he practice-- where a broker executes both a buy and sell order for the same security from one client account to another where both accounts are managed by the same portfolio manager—can sometimes result in a client not getting the best price on its purchase or sale. That is because the trade doesn’t get recorded through an exchange.Therefore, the asset manager must be able to prove to the SEC that the trade was beneficial to both parties and the trade must be recorded as a cross. The asset manager must also disclose the practice to its customers, Nadel did neither.
In his Form ADV – the documentation investment advisers use to register with the SEC, Nadel said that he used the brokerage firm he controlled because that firm would “deal with other brokers or dealers and can provide the best execution for orders on behalf of the accounts.” And Nadel also erroneously said that he valued the securities he traded at “the prevailing market value” by contacting market markers at the end of each month to obtain so-called “inside market (highest bid and lowest offer) prices.
However, the prices Nadel reported on his trade confirmations and those stated in his monthly were reports were “fictitious.” When clients did question him about the difference between his valuations and those contained in his clearing firm’s monthly statements or in independent pricing reports, Nadel touted his “20-year expertise” and his “contacts with market-makers,” the SEC said.
Nadel never maintained any record of the way he valued his client’s holdings and he did not store any order tickets. Primoff would not comment on whether Nadel's clearing firm ever investigated the discrepancies between its monthly statements and the ones Nadel was mailing to customers..