SEC Shuts Down RIA Cherry Picking

December 21, 2016

In a recent Securities and Exchange Commission ("SEC") settlement, we are presented with TPG Advisors, LLC, a California limited liability company registered with the SEC as an investment adviser ("RIA"). TPG was founded in 2009 by Larry M. Phillips, 66, who was the firm's sole owner, principal, and Chief Compliance Officer. Phillips, who held securities industry registrations since 1971, was also dually registered with a registered broker-dealer. Going by TPG's May 2015 Form ADV, this RIA had about 280 clients, 852 accounts, and a total of $220 million in assets under management. Almost all of TPG's clients were individuals rather than entities. On August 9, 2016, TPG shuttered its business and withdrew its SEC registration.

Let's imagine that you were approached by Phillips and that he pitched you on allowing his RIA to handle your business. Let's pretend that you did some minimal due diligence to ascertain Phillips' bona fides. What do you think you may have discovered?

BrokerCheck Check-Up

According to the Financial Industry Regulatory Authority's ("FINRA's") online BrokerCheck database, a search of "Larry M. Phillips" reveals that Phillips was registered with FINRA member firms Albert & Maguire Securities Co., Inc. (June 1971 to May 1972); various Dean Witter iterations from June 1972 to August 1992; Prudential Securities Incorporated (August 1992 to March 1996); Wachovia Securities (April 1996 to November 2003); RBC Capital Markets Corporation (December 2003 to November 2009), and Purshe Kaplan Sterling Investments (December 2009 to April 2016).

Under the BrokerCheck heading of "Separation After Allegations," we see that Prudential Securities Incorporated permitted Phillips to resign on February 20, 1996, based upon allegations that he had improperly hired support personnel. All in all, not that big a deal in the grand scheme of Wall Street regulation and in-house compliance. It's what comes next that is more troublesome.

Under the BrokerCheck heading of "Customer Dispute - Settled" we find two disclosures:

  1. Wachovia reported receipt on January 8, 2008, of a customer complaint alleging $130,000 in damages arising from a dispute Variable Annuity transaction. That matter settled for $25,000 on December 3, 2009, and Phillips is reported has not having contributed to the settlement; and
  2. Dean Witter reported receipt on January 1, 1983, of a customer complaint alleging $70,000 in damages arising from allegedly unauthorized and unsuitable transactions. That matter settled for $20,500 on October 1, 1991, and Phillips is reported as not having contributed to the settlement.

Under the BrokerCheck heading "Regulatory - Final," we find a 2005 NASD AWC. For the purpose of proposing a settlement of rule violations alleged by the NASD, without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, Larry M. Phillips submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which NASD accepted. In the Matter of Wachovia Securities, Inc., Larry M. Phillips, and Richard J. DiCenso, Respondents (AWC CE2050007, April 13, 2005). As set forth in the "Summary" section of the 2005 NASD AWC:

During the period May 25,2001, through April 12, 2002, Wachovia, acting through registered representative Phillips, created and distributed a total of 26 written communications that failed to disclose adequately material facts regarding investment products and strategies, or made exaggerated, unwarranted or misleading statements or claims regarding those products, or both. Wachovia, acting primarily through branch manager DiCenso, failed to supervise reasonably Phillips's written communications activities in connection with 20 pieces of correspondence and 6 pieces of sales literature. In addition, Wachovia failed to file Phillips's sales literature with NASD.

Wachovia also failed to establish and maintain procedures that were reasonably designed to achieve compliance with NASD's requirement for filing sales literature within 10 days of first use.

2006 State of Illinois Consent Order

Also under the BrokerCheck heading "Regulatory - Final" is In the Matter of Larry M. Phillips (Consent Order of Dismissal, State of Illinois, File No. 0500301; October 13, 2006). As a result of the conduct cited in the 2005 NASD AWC, Phillips entered into a stipulated settlement with the State of Illinois whereby he agreed in pertinent part that he:

[S]hall not serve his dealer ("RBC Dain Rauscher, Inc.") in the capacity of Designated Principal for the offer or sale of securities in the State of Illinois., for a period of Two (2) Years from the entry of this Consent Order.  

3. The Respondent is levied costs of investigation in this matter in the amount of One Thousand dollars ($1,000.00), payable to the Office of the Secretary of State, Securities Audit and Enforcement Fund, and on the 13th of October has submitted One Thousand dollars ($ 1,000.00) in payment thereof.


A third BrokerCheck disclosure under the heading "Regulatory -- Final" is a 2015 FINRA regulatory settlement. For the purpose of proposing a settlement of rule violations alleged by the Financial Industry Regulatory Authority ("FINRA"), without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, Larry M. Phillips submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of Larry M. Phillips, Respondent (AWC  2011027842701, April 27, 2015). As set forth in the preliminary sections of the 2015 FINRA AWC, we are informed:


In April 2005, Phillips entered into an AWC with NASD in which he was suspended for 10 business days and fined $20,000 for creating and distributing written communications that failed to adequately disclose material facts regarding investment products and strategies, or made exaggerated, unwarranted or misleading statements or claims regarding those products, or both.

In October 2006, Phillips was sanctioned in a proceeding brought by the State of Illinois based on the above-referenced NASD action. As a result, he was prohibited from serving as a principal in Illinois for two years and required to pay $1,000 for the costs of the investigation.

As set forth in more detail, the 2015 FINRA AWC asserts:


From January 2010 through August 2010, Phillips, through PKS, purchased products - including Steepener Notes, Steepener CDs, Floating Rate Notes, Principal Protected Notes and Municipal Securities - for certain of his investment advisory clients. Phillips added a markup to these transactions. Phillips then allocated the marked-up products to his clients' investment advisory accounts, where Phillips charged advisory fees on the same products for which he had previously charged a markup. By assessing both a markup and an investment advisory fee on the same products, Phillips overcharged his clients in violation of FINRA Rule 2010 and MSRB Rule G-17.

In accordance with the terms of the 2015 AWC, FINRA imposed upon Phillips a $7,500 fine; a 45-calendar-day suspension from association with any FINRA member in any and all capacities; and ordered him to make $3,436.81 in restitution to specified customers.

2016 SEC Order

The final disclosure under the BrokerCheck heading"Regulatory -- Final" is the recent SEC settlement that is the subject of today's Blog analysis.

In anticipation of the institution of proceedings by the Securities and Exchange Commission ("SEC") but without admitting or denying the findings, TPG Advisors LLC D/B/A The Phillips Group Advisors, and Larry M. Phillips submitted an Offer of Settlement, which the federal regulator accepted.  In the Matter of TPG Advisors LLC D/B/A The Phillips Group Advisors, and Larry M. Phillips, Respondents (Order Making Findings and Imposing Remedial Sanctions and a Cease-And-Desist Order;  '34 Act Rel. No. 79568; Invest. Adv. Act Rel. No. 4588; Invest. Co. Act Rel. No. 32394; Admin. Proc. File No. 3-17217 / December 15, 2016) As set forth in the "Summary" section of the 2016 SEC Order:

Respondent TPG, an investment adviser formerly registered with the Commission, through its sole owner and principal Respondent Phillips, engaged in fraudulent trade allocations - "cherry-picking." From at least January 2010 to at least August 2014, TPG and Phillips unfairly and systematically allocated profitable trades to a set of accounts while other accounts were harmed by the allocation of unprofitable trades.


TPG's Trade Allocation Policies

4. TPG's Forms ADV Part 2A, which were provided to clients, stated that TPG sought "to allocate trade executions in a most equitable manner possible" through "consistently non-arbitrary methods of allocation." All ten Forms ADV Part 2A filed by TPG from February 2011 through May 2015 used the same language. TPG's internal written policies and procedures required equitable trade allocation. Specifically, TPG's compliance manual states: "TPG will not allocate trades in such a way that TPG's own or affiliated account(s) (including those of supervised persons) or selected Clients receive more favorable treatment than TPG's other Client accounts." TPG's compliance manual also states that in any aggregated trade, "[n]o advisory Client will be favored over any other Client," and that the adviser would "prepare, before entering an aggregated order, a written statement (Allocation Statement) specifying the participating Client accounts and how it intends to allocate the order among those Clients." To ensure that no account was favored, the compliance manual stated that "[p]eriodic reviews should be conducted to ensure no accounts are being systematically disadvantaged."

TPG and Phillips Favored Certain Accounts

5. Contrary to TPG's Forms ADV Part 2A and internal policies and procedures, Phillips did not allocate equities and options trades equitably. From at least January 2010 to August 2014, Phillips unfairly allocated a disproportionate number of profitable equity and options trades to at least six favored accounts held by at least four favored clients and allocated unprofitable trades to certain other, disfavored client accounts. Phillips had personal connections to the favored clients, which included (1) Phillips' lifelong family friend; (2) Phillips' cousin; (3) a long-standing, high-net worth client with a background in the entertainment industry; and (4) a client whom Phillips had served for over twenty years and whose mother had also been a longtime client of Phillips.

6. TPG's client accounts are held in custody by a third-party broker. TPG and Phillips traded securities initially in a master account without allocating the trade to a specific client account. If a security could be bought and sold in a day for a profit, then TPG and Phillips usually allocated those profitable "day trades" to favored accounts. To do so, the position would be closed in the master account, a positive gain would be realized on the trade and that profitable day trade would then be allocated to one of the favored accounts. But if the security could not be closed for a gain on the day it was purchased, the security was not sold and was usually allocated to one of the disfavored accounts. TPG's favored clients received first-day profits on day trades that were virtually impossible to have achieved by chance.

7. Certain accounts had a large proportion of day trades, while other accounts had almost none. For the six most-favored accounts, more than 90% of the trades were day trades and more than 90% of the trades in the account had single-day profits. By contrast, in at least eleven accounts in which only a small proportion of the trades were day trades, the vast majority of trades had unrealized losses in the first day.

8. The performance in each of the six most-favored accounts is a statistical anomaly. The likelihood that their profitability originated from random chance is less than 1%. Similarly, the performance in each of the eleven harmed accounts is also a statistical anomaly. Random chance would have provided them with better performance with a probability exceeding 99%.

9. By disproportionately allocating the more favorable trades to the favored accounts through this cherry picking scheme, TPG and Phillips provided a benefit to the favored clients and inflicted harm on the disfavored clients.

10. TPG and Phillips had been expressly warned about their allocation process by the third-party broker that maintained custody of the accounts. Between March 2010 and January 2015, the third-party broker's trade allocation surveillance system flagged TPG for suspicious trade allocations at least twenty-one times. From August 2010 to December 2012, the broker's employees called Phillips at least five times about TPG's allocation practices, each time making suggestions that Phillips disregarded. The broker's employees instructed Phillips to trade directly in the clients' accounts instead of the master accounts, but Phillips failed to follow the broker's instructions. The broker also suggested, and Phillips appeared to agree, that the accounts receiving the profitable day trades at issue be moved to another master account so they could be identified as day-trading accounts, but Phillips failed to comply with that suggestion. While TPG has multiple master accounts, only one is used regularly and no master account appears to be limited to the daytrading clients.

SEC Sanctions

In accordance with the terms of the Offer of Settlement, the SEC ordered that Respondents cease and desist from violations of securities laws. Phillips was:

  • barred from association with any broker, dealer, investment adviser, municipal securities dealer, municipal advisor, transfer agent, or nationally recognized statistical rating organization;
  • barred from participating in any offering of a penny stock, including: acting as a promoter, finder, consultant, agent or other person who engages in activities with a broker, dealer, or issuer for purposes of the issuance or trading in any penny stock or inducing or attempting to induce the purchase or sale of any penny stock; and
  • prohibited from serving or acting as an employee, officer, director, member of an advisory board, investment adviser or depositor of, or principal underwriter for, a registered investment company or affiliated person of such investment adviser, depositor, or principal underwriter.

Respondents were ordered to jointly and severally disgorge $25,295.00 plus $3,142.69 prejudgment interest, and to pay a $300,000 civil monetary penalty.

Bill Singer's Comment

The main point of today's exercise is to alert investors to the wide array of due-diligence tools that you can easily avail yourself of -- frankly, the effort required is little more than resorting to a search of FINRA's BrokerCheck or a basic search via Google or whatever search engine you prefer. Whether the background of Phillips is such that potential clients should have asked more questions or simply declined to work with him and his firm is something that I will leave to each individual to determine on their own. The issue is simply one of notice. And once you're on notice, you're really not all that sympathetic if you get ripped off and the best that you can offer in your defense is "I didn't have any reason to question him."  There comes a point when "how should I know?" is an idiotic excuse.