Portfolio manager trade allocations are now under intense regulatory scrutiny after federal prosecutors charged a prominent bond fund manager at Western Asset Management Company with a $600 million “cherry-picking” scheme. This high-profile case has prompted investment management firms to reassess their trading policies and practices to ensure compliance with fiduciary standards.
On November 25, the U.S. Attorney’s Office for the Southern District of New York indicted Ken Leech, the former co-chief investment officer at Western, a division of Franklin Resources. Leech faces four counts of fraud and one count of making false statements. Simultaneously, the Securities and Exchange Commission (SEC) filed civil charges against him, alleging he engaged in a multiyear scheme to allocate favorable trades to certain portfolios while assigning less favorable trades to others—a violation commonly referred to as cherry-picking.
Industry Impact and Increased Compliance Focus Investment advisors are legally and ethically obligated to prioritize their clients’ best interests in all activities, including trade allocations, noted Sanjay Wadhwa, acting director of the SEC’s Division of Enforcement. Western Asset has cooperated with the investigation and has since enhanced its trading policies and practices based on a third-party review, according to spokesperson Jeaneen Terrio.
The fallout from this case is reverberating across the industry. Morningstar analyst Max Curtin predicts heightened regulatory focus on trade allocation practices, emphasizing that money managers are bracing for closer scrutiny. “Allocation of trades is the crux of this issue,” Curtin says, underscoring the importance of transparent and equitable practices.
Challenges in Fixed-Income and Derivatives Allocation The alleged misconduct at Western also highlights challenges within trade order management systems, which are more robust for equity transactions than for fixed-income and derivatives trading. Salvatore Faia, president and CEO of Vigilant Compliance, explains that while order management systems can automate equity trade allocations efficiently, they are less effective for more complex instruments like bonds and derivatives. This creates room for manual processes, increasing the risk of deviations from stated trade allocation policies.
“The trade allocation software is more adept at equity trading, where allocations can be calculated automatically based on share price,” Faia explains. “With fixed income or derivatives, the process becomes more manual, potentially allowing for subjective decisions.” Such gaps could enable portfolio managers to favor certain accounts, a practice regulators are keen to eliminate.
Balancing Fairness in Trade Rotations
For managers handling both institutional and wealth management accounts, trade rotation is a common practice aimed at fostering fairness. However, as David Choate, COO at Capis, notes, even trade rotation can create disparities among clients. “Trade rotation can inadvertently create winners and losers,” Choate says, adding that fixed-income transactions often bypass trade rotation entirely due to the nature of settlement processes and platform limitations.
Choate further emphasizes that the industry needs to address the challenges of trade allocation and rotation comprehensively, particularly for complex instruments like derivatives. “Most wealth platforms cannot hold derivatives, making trade rotation less applicable,” he explains.
Regulatory Priorities and Industry Responses
The SEC has been intensifying its examination of trade allocation practices, seeking to identify instances where certain clients may have been unfairly favored. Vigilant Compliance has observed a rise in advisory exams focused on fiduciary duties, including trade allocations. Faia notes that the SEC’s priorities for fiscal year 2025, which began October 1, explicitly highlight investment advisors’ adherence to fiduciary standards as a key focus.
Since reports of the Western case emerged, many money managers have proactively sought external reviews of their trade allocation policies to ensure compliance. Faia confirms that firms are increasingly aware of the SEC’s heightened interest and are taking steps to strengthen their procedures. “This is about protecting clients and adhering to fiduciary standards,” he says.
Case Details and Broader Implications
The SEC’s complaint against Leech alleges that he circumvented Western’s electronic trading system and failed to document intended allocations at the time of trades. Instead, he relied on informal communication with brokers, a departure from established policies. These actions, according to the SEC, violated fiduciary responsibilities and disadvantaged certain clients.
Leech’s attorney has dismissed the allegations as baseless, asserting that the portfolio manager derived no personal benefit from the alleged misconduct. Regardless of the outcome, the case underscores the critical need for robust compliance frameworks in the investment management industry.
Looking Ahead: Regulatory Landscape Under Scrutiny While the Trump administration has signaled a deregulatory agenda for the financial services sector, experts like Faia believe the SEC’s focus on trade allocation and rotation practices will remain steadfast. “Trade allocation issues directly impact investor protection, so I don’t foresee significant shifts in the SEC’s approach,” he says.
For wealth advisors and RIAs, the case serves as a stark reminder of the importance of rigorous trade allocation practices. Ensuring that all clients are treated equitably, especially in complex asset classes like fixed income and derivatives, is essential to maintaining trust and meeting fiduciary obligations. By proactively reviewing and enhancing compliance frameworks, firms can navigate this heightened regulatory environment effectively while continuing to serve their clients’ best interests.
