Two former Cetera advisors are staring down SEC allegations over a "cherry-picking" scheme in which they kept the best results from their stock trades for themselves and reserved the worst for their clients.
William D. Carlton and Hans K. Hernandez were sued separately by the Securities and Exchange Commission in federal courts on Friday over their alleged participation in yearslong cherry-picking ploys that cost their clients millions. Carlton, a resident of Kirkland, Washington, is accused of making $5.3 million off first-day trading profits while costing his clients $6.4 million as he ran his scheme from early 2015 to mid-2022. Hernandez, of Hillsborough, New Jersey, is similarly alleged to have made more than $1 million in first-day profits and cost his clients $1.7 million between July 2020 and February 2022.
Heads, I win; tails, you lose
Both advisors, fired by Cetera last year after the allegations arose, stand accused of using their personal accounts to make stock trades through a brokerage firm that goes unnamed by the SEC. Carlton and Hernandez would then both wait to see if their stock purchases rose in value or fell.
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If they went up, the pair almost always would keep the resulting profits for themselves. If they fell, Carlton and Hernandez would tell the outside brokerage firm to allocate most of the losses to their clients' accounts, according to the SEC.
With Carlton, who was working with anywhere from 50 to 70 clients at different times, the SEC found that nearly 70% of the trades initiated in his own accounts resulted in profits for himself. Of the trades allocated to clients, only 14% were profitable.
Carlton's trading, according to the SEC, produced first-day returns in his own accounts of 0.5% and first-day losses in his clients' accounts of 2.1%.
"A statistical test of the difference in first-day returns between [Carlton's] accounts and his client accounts finds that the likelihood of this disparity happening by chance is nearly zero," the SEC said.
Settlements with Cetera, First Allied
The SEC separately reached a settlement over the alleged cherry-picking scheme with both Cetera and First Allied Advisory Services, a San Diego, California-based firm that Cetera bought in 2013. Both Carlton and Hernandez were with First Allied for more than decade before it was rolled into Cetera's brand in 2022.
The SEC alleged that First Allied failed to follow internal policies saying that its advisors had to have plans in place regarding how they would distribute profits from any future stock trades before the transactions actually took place. Cetera was similarly faulted for failing to ensure Carlton's and Hernandez's transactions were not being run through an internal system meant to prevent changes in allocation plans after trades had already been placed.
Cetera, which came in as the No. 4 largest independent broker-dealer this year in
A spokesperson for Cetera said, "Upon learning about this issue, Cetera acted promptly to cease the activity and previously terminated these individuals' affiliations with Cetera. We have established processes in place to prevent any similar actions in the future. Cetera has fully cooperated with the SEC in this case and will continue to do so as the SEC pursues action against these individuals."
Lou Straney, a regulatory expert at
"A firm is in the best position to prevent this, and if you don't do it, you're going to be in trouble," he said. "These things are typically detected within 24 hours and never go on for this length of time."
Difference a day makes
Cetera, according to the SEC, did step in in September 2022 and place a ban on Carlton's ability to allocate stock trades to clients after they had been made in his personal accounts. Almost immediately, the lawsuit states, his returns disappeared.
During the period of Carlton's alleged cherry-picking scheme, according to the SEC, his personal accounts saw positive first-day returns in 89 out of 92 months. After Cetera halted his ability to allocate money out of those accounts, he saw positive first-day returns in only six of the next 16 months.
"Conversely, during Carlton's cherry-picking scheme, Carlton's client accounts suffered first-day losses and negative first-day rates of return every single month for more than seven years," according to the SEC.
The SEC's suit against Hernandez says that he admitted in an interview that he had not already decided when placing trades how he would allocate any resulting profits or losses. The SEC is seeking the disgorgement of ill-gotten gains, prejudgment interest and civil penalties from both defendants.
The Jarkesy effect
Edwards said he's particularly curious to see how the Seattle-based federal court in which Carlton's case is being tried will handle the perhaps unfamiliar terrain of securities law.
"There is no reason you can't reach the same outcome," he said. "But the way the SEC is going to proceed will maybe be a bit different than if they were dealing with a judge with a high level of familiarity with these types of securities claims, perhaps in a court in [Washington,] D.C. or New York."
