On April 19, 2013, the SEC settled charges against Foxhall Capital Management, Inc. (“Foxhall”), a registered investment adviser (“RIA”), and Paul G. Dietrich (“Dietrich”), Foxhall’s Chief Executive Officer, Co-Chief Investment Officer and former Chief Compliance Officer, for reallocating trades among its client accounts in violation of its written compliance policies and procedures and for failing to maintain complete and accurate records of its trading and reallocation procedures.
According to the SEC, Foxhall offers clients discretionary portfolio management based on model portfolios that are designed to meet a client’s investment goals and risk tolerance. According to the SEC, in managing such portfolios, Foxhall would aggregate client orders in block trades, then allocate trades to clients according to its clients’ chosen model portfolio and the clients’ account balances. According to the SEC, however, between January 1, 2007 and September 3, 2009, Foxhall’s trade management system was incompatible with its primary broker dealer and custodian’s trading platform, which caused real-time trade reconciliation problems. Specifically, the SEC alleged that Foxhall traders sometimes did not have accurate real-time information from the custodian regarding the current account balances of Foxhall’s clients, which led to certain Foxhall clients being allocated shares from block trades despite not having sufficient funds in their accounts to purchase the shares, which caused such shares to become “unallocated shares.” The SEC alleged that Foxhall would learn about the unallocated shares three to five days later, at which point Foxhall would, using the now stale original execution price, reallocate the unallocated shares to other client accounts with sufficient funds that were assigned to the same model portfolio (or alternatively, Foxhall would sell the unallocated shares through its own error account). The SEC alleged that this practice caused clients who were reallocated shares (or Foxhall, if unallocated shares were sold through its error account) to sometimes overpay or underpay for the reallocated shares, since the shares’ prices might have increased or decreased since the original execution of the block trade.
According to the SEC, rather than treat the more than 400 instances in which Foxhall reallocated shares as trading errors, which, under Foxhall’s compliance procedures, would have required Foxhall to document the errors, to conduct a profit and loss analysis and to repay clients for losses, Foxhall deemed the reallocations to be “administrative errors.” According to the SEC, however, Foxhall should have kept complete and accurate records concerning its trades, including with respect to its unallocated share practices. In addition, the SEC alleged that Foxhall and Dietrich failed to conduct an annual review of the firm’s written compliance policies and procedures.
Based on such conduct, the SEC charged that Foxhall violated (and that Dietrich aided and abetted Foxhall’s violation of) Section 206(4) of the Advisers Act and Rule 206(4)-7 thereunder, which requires RIAs to implement policies and procedures reasonably designed to prevent violations of the Advisers Act and its rules (and for RIAs to review such policies and procedures annually) and Section 204 of the Advisers Act and Rule 204-2(a)(3) thereunder, which requires, among other things, that an RIA keep a record of each order given or instruction received for the purchase or sale of a security (including any “modification or cancellation” of any such order or instruction).
Without admitting or denying the SEC’s findings, Foxhall and Dietrich agreed to settle the charges. The SEC censured Foxhall and Dietrich, ordered each to cease and desist from future violations of the relevant provisions of the Advisers Act, and ordered Foxhall to pay disgorgement and prejudgment interest and Foxhall and Dietrich to pay a civil penalty ($100,000 for Foxhall and $25,000 for Dietrich). According to the SEC, in agreeing to the settlement, the SEC took into consideration Foxhall’s and Dietrich’s prompt remedial efforts, including that Foxhall changed it primary custodian, upgraded its trading platform, hired a compliance consultant to perform annual compliance reviews and to evaluate Foxhall’s compliance practices and procedures, retained a third-party compliance consultant as its Chief Compliance Officer and hired an independent accountant to analyze the effect of reallocated shares on Foxhall’s clients.