Robert Khuzami, Director of the Division of Enforcement, SEC

SEC charges optionsXpress over abusive naked short selling scheme

The Securities and Exchange Commission has charged an online brokerage and clearing agency specialising in options and futures as well as four officials at the firm and a customer involved in an abusive naked short selling scheme.

The SEC’s Division of Enforcement alleges that Chicago-based optionsXpress failed to satisfy its close-out obligations under Regulation SHO by repeatedly engaging in a series of sham “reset” transactions designed to give the illusion that the firm had purchased securities of like kind and quantity. The firm and customer Jonathan I. Feldman engaged in these sham reset transactions in a number of securities, resulting in continuous failures to deliver. Regulation SHO requires the delivery of equity securities to a registered clearing agency when delivery is due, generally three days after the trade date (T+3). If no delivery is made by that time, the firm must purchase or borrow the securities to close out the failure-to-deliver position by no later than the beginning of regular trading hours on the next day (T+4).

The former chief financial officer at optionsXpress – Thomas E Stern of Chicago – was named in the SEC’s administrative proceeding along with optionsXpress and Feldman. Three other optionsXpress officials – head of trading and customer service Peter J. Bottini and compliance officers Phillip J Hoeh and Kevin E Strine – were named in a separate administrative proceeding and settled the charges against them for their roles in the scheme.

“OptionsXpress used sham reset transactions to avoid, sometimes for months, its obligation to comply with Reg. SHO’s stock delivery requirements,” says Robert Khuzami (pictured), Director of the Division of Enforcement. “Illegally extending its naked short positions put optionsXpress in plain violation of the law and undermined Reg. SHO’s intent to reduce fails to deliver.”

Daniel M Hawke, Chief of the Division of Enforcement’s Market Abuse Unit, says: “Reg. SHO compliance continues to be a high enforcement priority. Broker-dealers, their employees, and their customers must ensure that they comply with the close-out requirements of the short sale rules and regulations.”

According to the SEC’s order, the misconduct occurred from at least October 2008 to March 2010. In September 2011, optionsXpress became a wholly-owned subsidiary of The Charles Schwab Corporation.
The SEC’s Enforcement Division alleges that the sham reset transactions impacted the market for the issuers. For example, from 1 January, 2010 to 31 January, 2010, optionsXpress customers including Feldman accounted for an average of 47.9 per cent of the daily trading volume in one of the securities. In 2009 alone, the optionsXpress customer accounts engaging in the activity purchased approximately USD5.7 billion worth of securities and sold short approximately USD4 billion of options. In 2009, Feldman himself purchased at least USD2.9 billion of securities and sold short at least USD1.7 billion of options through his account at optionsXpress.

According to the SEC’s order, by engaging in the alleged misconduct, optionsXpress violated Rules 204 and 204T of Regulation SHO; Feldman wilfully violated Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 and Rules 10b-5 and 10b-21 thereunder; optionsXpress and Stern caused and willfully aided and abetted Feldman’s violations of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rules 10b-5 and 10b-21 thereunder; and Stern caused and wilfully aided and abetted optionsXpress’s violations of Rules 204 and 204T.

In the separate settled administrative proceeding, Bottini, Hoeh, and Strine consented to a cease-and-desist order finding that they caused optionsXpress’s violations of Rules 204 and 204T of Regulation SHO and ordering them to cease-and-desist from committing or causing violations of Rule 204. They neither admitted nor denied the SEC’s findings.

The SEC’s investigation was conducted by Deborah Tarasevich, Jill Henderson, and Paul Kim. Market Surveillance Specialist Brian Shute, Market Abuse Unit Trading Specialist Ainsley Fuhr, and Financial Economist Michael P Barnes provided assistance with the investigation. The litigation will be led by Frederick Block.
 

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