SEC CHARGES INVESTMENT ADVISER IN ALGORITHMIC TRADING ABILITY CASE

FROM:  SECURITIES AND EXCHANGE COMMISSION 
SEC Charges North Carolina-Based Investment Adviser for Misleading Fund Board About Algorithmic Trading Ability
08/21/2013 10:43 AM EDT

The Securities and Exchange Commission today announced charges against a North Carolina-based investment adviser and its former owner for misleading an investment fund’s board of directors about the firm’s ability to conduct algorithmic currency trading so they would approve the firm’s contract to manage the fund.

The SEC’s Enforcement Division alleges that Chariot Advisors LLC and Elliott L. Shifman misled the fund’s board about the nature, extent, and quality of services that the firm could provide as he touted the competitive benefits of algorithmic trading in two presentations before the board.  Contrary to what Shifman told the directors, Chariot Advisors did not devise or otherwise possess any algorithms capable of engaging in the currency trading that Shifman was describing.  After the fund was launched, Chariot Advisors did not use an algorithm model to perform the fund’s currency trading as represented to the board, but instead hired an individual trader who was allowed to use discretion on trade selection and execution.  The misconduct by Shifman and Chariot Advisors caused misrepresentations and omissions in the Chariot fund’s registration statement and prospectus filed with the SEC and viewed by investors.

The case arises out of an initiative by the SEC Enforcement Division’s Asset Management Unit to focus on the “15(c) process” – a reference to Section 15(c) of the Investment Company Act of 1940 that requires a registered fund’s board to annually evaluate the fund’s advisory agreements.  Advisers must provide the board with the truthful information necessary to make that evaluation.  Other enforcement actions taken against misconduct in the investment contract renewal process and fee arrangements include cases against Morgan Stanley Investment Management, a sub-adviser to the Malaysia Fund, and two mutual fund trusts affiliated with the Northern Lights Variable Trust fund complex.

“It is critical that investment advisers provide truthful information to the directors of the registered funds they advise,” said Julie M. Riewe, Co-Chief of SEC Enforcement Division’s Asset Management Unit.  “Both boards and advisers have fiduciary duties that must be fulfilled to ensure that a fund’s investors are not harmed.”

According to the SEC’s order instituting administrative proceedings, the false claims by Chariot and Shifman defrauded the Chariot Absolute Return Currency Portfolio, a fund that was formerly within the Northern Lights Variable Trust fund complex.  In December 2008 and again in May 2009, Shifman misrepresented to the Chariot fund’s board that his firm would implement the fund’s investment strategy by using a portion of the fund’s assets to engage in algorithmic currency trading.  Chariot fund’s initial investment objective was to achieve absolute positive returns in all market cycles by investing approximately 80 percent of the fund’s assets under management in short-term fixed income securities, and using the remaining 20 percent of the assets under management to engage in algorithmic currency trading.

According to the SEC’s order, Chariot Advisors did not have an algorithm capable of conducting such currency trading.  The ability to conduct currency trading was particularly significant for the Chariot fund’s performance, because in the absence of an operating history the directors focused instead on Chariot Advisors’ reliance on models when the board evaluated the advisory contract.  Even though Shifman believed that the fund’s currency trading needed to achieve a 25 to 30 percent return to succeed, Shifman never disclosed to the board that Chariot Advisors had no algorithm or model capable of achieving such a return.

According to the SEC’s order, because Chariot Advisors possessed no algorithm, currency trading for the fund was under the control of an individual trader who was not using an algorithm for at least the first two months after the fund’s launch.  Shifman had interviewed the trader prior to her hiring and knew that she used a technical analysis, rules-based approach for trading that combined market indicators with her own intuition.  The trader traded currencies for the fund until Sept. 30, 2009 when she was terminated due to poor trading performance. Subsequently, Chariot employed a third party who utilized an algorithm to conduct currency trading on behalf of the Chariot fund.

The SEC’s order alleges that the misconduct by Chariot and Shifman, who lives in the Raleigh area, resulted in violations of Sections 15(c) and 34(b) of the Investment Company Act of 1940 and Sections 206(1), 206(2), and 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-8.  A hearing will be scheduled before an administrative law judge to determine whether the allegations contained in the order are true and whether any remedial sanctions are appropriate.

The SEC’s investigation was led by Stephen E. Donahue and John G. Westrick of the Asset Management Unit and Atlanta Regional Office as well as Micheal D. Watson of the Atlanta office.  Pat Huddleston and Shawn Murnahan will lead the Enforcement Division’s litigation.  John Sherrick and Timothy J. Barker of the Atlanta Regional Office conducted the related examination that led to the investigation.