Articles Posted in Short Selling

The U.S. Supreme Court has issued a unanimous ruling allowing investors to sue Bank of America Corp’s Merrill Lynch (BAC) and other brokerage firms in New Jersey state court even though the lawsuit cites federal laws. The plaintiffs, who are Spectrum Group International Inc. investors, claim that they sustained investment losses because the brokers engaged in illegal short-selling. They are invoking NJ’s RICO statute in their case. RICO is the Racketeer Influenced and Corrupt Organizations Act. It is a federal law that allows for victims of organized crime to seek civil damages. It also provides provisions for other extended penalties. Bank of America Merrill Lynch claims that this naked short selling case is meritless.

The plaintiffs are accusing Merrill Lynch and other broker-dealers of playing a part in causing Spectrum’s market capitalization to drop by $800M in 11 months. The investors said that the firms did this by helping naked short sellers who bet against the company, causing its share price to plunge.

Naked Short Sales
A short sale involves the use of borrowed shares to bet that a security’s price with drop. The short sale is naked if the trader doesn’t borrow the shares required to make the transaction happen. Under Regulation SHO, naked short sales cannot be used to manipulate a security. Still, lawsuits over illegal naked short selling haven’t done too well in federal court.

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Andrew L. Evans, a trader living in Canada, has consented to pay over $1 million to resolve charges that he shorted U.S. stocks in companies planning follow-on offerings and then illegally purchased shares in the offerings to generate substantial profits at little to no risk. The Securities and Exchange Commission said that through his firm Maritime Asset Management, Evans violated Rule 105, federal securities laws’ anti-manipulation provision, multiple times.

Under Rule 105, short selling in an equity security is not allowed during the restricted period, which is typically five days leading up to a public offering, nor is buying the security via the offering. By buying the shares at a lower price in the follow-on offerings that could cover his sort sales, Evans allegedly made over $580K in illegal profits.

The SEC said that the short selling violations happened between 12/10 and 5/12. Under the settlement, Evans must pay over $582K in disgorgement, more than $63K in prejudgment interest and a penalty of more than $364K. A court must still approve the settlement.

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The SEC said that Merrill Lynch (MER) would pay $11 million to resolve allegations of short-selling-related noncompliance. The regulator said that the wirehouse executed short sales in certain securities when the supply for this type of transaction was restricted.

Customers frequently ask brokerage firms to “locate” stock that can be used for short selling. The financial firms generate easy-to-borrow lists made up of the stock they believe is accessible for such locates. However, contends the SEC, from January 2008 through January 2014 Merrill used information that was dated to create these ETB lists.

For example, there were times when certain securities that were placed on the ETB list in the morning were no longer as easily available for borrowing later in the trading day. Yet Merrill’s platforms were set up so that they continued to process short sale orders according to the now-dated list—even as firm personnel appropriately stopped using the list for sourcing locates when certain shares’ availability had become restricted.

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The Financial Industry Regulatory Authority is fining Morgan Stanley & Co. LLC (MS) $2M for violations involving short sale and short interest reporting rules. The violations purportedly took place over six years. The financial firm is also accused of not putting into place a supervisory system designed in a reasonable enough manner that it could identify and prevent such violations.

Financial firms are supposed to report to the SRO on a regular basis their total short positions involving equity securities in proprietary firm and customer accounts. However, according to the self-regulatory organization, Morgan Stanley did not accurately and completely report such positions in certain securities that involved billions of shares. FINRA also said that the firm’s supervisory system was deficient.

Meantime, under U.S. Securities and Exchange Commission’s Regulation SHO for regulating short sales, firms are supposed to aggregate their positions in a security to determine whether they are short or long. Through an aggregation unit, Regulation SHO lets firms track positions in a security separate from other positions at the firm and via certain trading desks or operations.

The Financial Industry Regulatory Authority has sanctioned First New York Securities LLC for short selling prior to participating in 14 public securities offerings. To settle, the firm, which is not denying or admitting to the charges, will pay a $400,000 fine, disgorgement of $516,000 plus interest, and is barred for six months taking part in secondary or follow-on offerings. It also has consented to an entry of the self-regulatory organization’s findings and will modify its supervisory system to make sure it is in compliance.

According to FINRA, from 9/10 through 4/13, First New York sold securities short within the five days going into the pricing of the public offerings in the securities. It would then buy securities in the offerings—purchasing over 670,000 shares after short selling 187,060 securities shares during those five days. The short sales artificially dropped share prices, which let First New York purchase the stocks at a lower cost. The firm bet against shares of companies that included Kinder Morgan Inc. and BlackRock Inc. (BLK).

Under the Securities Exchange Act of 1934’s Rule 105 of Regulation M, brokers are not allowed to buy securities in secondary offerings when during the restricted period prior to the pricing of the secondary offering the buyer sold short the security that is the offering’s subject. Please contact our securities lawyers to request your free case consultation. SSEK Partners Group represents high net worth individual investors and institutional investors who wish to get their securities fraud losses back.

The Chicago Board Options Exchange, which is the largest options exchange in the United States, has consented to pay $6 million penalty to settle Securities and Exchange Commission charges accusing it of not fulfilling its obligation to enforce trading rules and failing to stop one firm member from engaging in abusive-short selling. The exchange is settling and taking corrective action but is not admitting to/denying wrongdoing.

While CBOE is an SRO (self-regulating organization), the SEC has wide oversight over trading. This is the first penalty that an exchange is paying for purported regulatory oversight failures. The Commission is also censuring the exchange, which means a tougher sanction could result if the alleged violation occurs again.

According to the regulator, in 2008, CBOE transferred the monitoring of member firms’ compliance via a rule for curbing abusive short-selling practices to a different department. This, contends the SEC, hurt the exchange’s ability to enforce the rule. (Short-selling involves a trader betting that a stock will drop in value. Short-sellers borrow the shares of a company, sell them, and then purchase them when the stock fails, giving them back to the lender while keeping the price difference. Unfortunately, too much short-selling focusing on weak companies can cause them to fail, inciting market volatility.)

In SEC v. Moshayedi, the Securities and Commission is suing the Chairman and CEO of computer device storage company STEC Inc. (STEC) for insider trading. Manouchehr Moshayedi allegedly traded in his company stock’s secondary offering because he had insider knowledge that there was a decline in the demand for an important product.

The SEC contends that Moshayedi was attempting avail of a sharp upward trend in the price of the company stock when he sold a significant amount of his shares, as well as shares belonging to his brother, who had co-founded the company with him. As a result of his actions, the Commission says that the siblings made gross proceeds of approximately $134 million each. Moshayedi has denied the allegations and intends to combat the case.

In another SEC case, two other brothers that were sued by the Commission for their alleged involvement in naked short selling have agreed to settle the administrative case against them by paying $14.5 million. Robert A. Wolfson and Jeffrey Wolfson are accused of not locating and delivering shares in short sales to brokerage firms. These naked-short selling transactions allegedly earned them about $9.5 million in illegal profits.

Golden Anchor Trading II LLC was also sued over this matter and has settled as well. While the Wolfsons are paying $13.4 million, the brokerage firm has agreed to pay $1.1 million. By settling, none of them are admitting to or denying the allegations.

Meantime, hedge fund adviser Chetan Kapur, who last year settled SEC administrative and civil charges over alleged misconduct related to allegations that he misled investors, has been indicted on the charges of investment adviser fraud, securities fraud, and wire fraud. Kapur was ThinkStrategy Capital Management LLC’s sole managing principal. The financial firm managed the hedge funds ThinkStrategy Capital Management LLC and ThinkStrategy Capital Fund.

According to the criminal charges, made in the U.S. District Court for the Southern District of New York, Kapur allegedly misled clients about the financial state of the two funds through material misstatements and omissions. He also is accused of giving false information about the funds’ performance, assets, longevity, due diligence, and personnel. If convicted, he faces up to 125 years in prison.

In other securities news, beginning August 2, underwriters will have to fulfill new disclosure obligations to local and state governments. This includes disclosing any actual or possible material conflicts of interest, any third party compensation, and any risks involving complex financial transactions that are recommended to clients. Earlier this month the Municipal Securities Rulemaking Board published guidance to assist underwriters in fulfilling these new duties.

SEC v. Moshayedi (PDF)

Short Selling Brothers Agree to Pay $14.5 Million to Settle SEC Charges
, SEC, July 17, 2012

SEC v. Kapur
(PDF)

MSRB Rule G-17 (PDF)

More Blog Posts:
No SIPA Coverage for Soft Dollar Credits, Says Bankruptcy Court, Institutional Investor Securities Blog, July 21, 2012

SEC’s Delay in Adopting Conflict Minerals Disclosure Rule is Impeding the Development of Initiatives for Issuer Compliance, Says GAO, Stockbroker Fraud Blog, July 27, 2012

Peregrine Financial Group Customers Were Victims of the “System,” Says CFTC Chairman Gensler, Institutional Investor Securities Blog, July 26, 2012

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