In a rare reversal, the SEC ruled last week that an in-house Administrative Law Judge erred in finding a securities trader liable for fraud in a short selling case.
The decision places the Commission in the rather unusual position of concluding that its ALJ was wrong and that its Enforcement Division failed to prove charges that the SEC voted to bring.
The SEC initially charged a Chicago-based broker-dealer, optionsXpress, for failing 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. As alleged, the firm and its customer, Jonathan I. Feldman, engaged in these sham reset transactions in a number of securities, resulting in continuous failures to deliver.
Chief ALJ Brenda P. Murray found that Feldman committed fraud, and that the firm aided and abetted his violations. She also found that optionsXpress committed technical violations of Regulation SHO. The Chief ALJ ordered Feldman to disgorge approximately $2.6 million, plus prejudgment interest, and to pay a civil money penalty of $2 million.
On appeal, the SEC found that “the record and the law” did not support a finding that Feldman committed fraud. There was also insufficient evidence that Feldman secretly intended not to deliver shares. According to the Commission opinion, “the record shows that Feldman was notably open about what he was doing.” While executing Feldman’s trades may have contributed to optionsXpress’s fails to deliver, the SEC concluded that responsibility for the fails belonged to optionsXpress, which allowed them to persist through optionsXpress’s own conduct.
The record also showed insufficient evidence to support a market manipulation charge under Exchange Act Rule 10b-5. The SEC rejected the Enforcement Division’s claim that Feldman’s various statements that he did not want to “settle” his position demonstrated that he was intentionally using buy-writes to avoid delivering shares. The Commission concluded that the evidence only indicated that Feldman was trying to avoid exiting, or settling, his overall position, not that he was attempting to prevent shares from being delivered to those exercising the options that he wrote.
Finally, the SEC found insufficient evidence of a violation of Exchange Act Rule 10b-21, the naked short-selling antifraud rule. In order to establish a violation, the division must establish that the trader deceived a broker-dealer or other parties. There was no evidence or claim that Feldman deceived optionsXpress, and the evidence was insufficient to show that he deceived downstream purchasers about his ability or intent to deliver shares. Feldman had been open about his trading strategy, had relied on the firm’s representations that his trades were not causing the fails to deliver, and had no way to know whether his trades were ultimately causing purchasers not to receive their shares.
As a result of the dismissal of all charges against Feldman, the SEC dismissed the claims that the firm aided and abetted his violations. The Commission did, however, uphold the Chief ALJ’s finding that the firm violated Regulation SHO, as well as the sanctions imposed below, a cease-and-desist order, an order to disgorge ill-gotten gains and a third-tier civil monetary penalty of $2 million.
More information on the decision can be found here.
In the Matter of optionsXpress, Inc. and Jonathan I. Feldman, SEC Release No. 33-10125 (Aug. 18, 2016).
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