Regulatory Roundup: Selective Gains, Collective Losses: The Cost of Cherry Picking

Analysis

When I took my kids blueberry picking recently, they carefully examined each berry. The plumpest ones went straight into their mouths, while the misshapen ones ended up in the basket. Unfortunately, some brokers and financial advisors never grow out of that habit.

Key Takeaways

• Cherry picking in financial markets involves brokers selectively allocating profitable trades to their own accounts or preferred clients, while assigning losing trades to other clients.
• The motivations for cherry picking can include client retention and artificially boosting the reported performance of specific funds to attract new investors or hit performance benchmarks.
• Regulatory bodies like the SEC and FCA use statistical analysis and regular audits to detect and prevent cherry picking, ensuring fair and transparent trade allocations. 

What Is Cherry Picking?

At its core, cherry picking occurs when a broker abuses their power to allocate trades. The broker selectively allocates profitable trades to their own account or to preferred clients, while losing trades are pushed onto other clients. This can happen when trades are executed in bulk, through omnibus accounts, and not allocated immediately. Brokers are expected to follow a fair, impartial and predetermined allocation process, but that doesn’t always happen.