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Cady Bar the Door Insight & Commentary on SEC Enforcement Actions and Related Issues

Friday Weekly Roundup

Posted in SEC Litigation

I’d like to try a weekly post with short bits recapping what I think are the most interesting stories or cases from the past week.  We’ll see how it works, but for this week:

  • Matt Solomon, an AUSA in the District of Columbia, was recently named Deputy Chief Litigation Counsel in the SEC’s trial unit.  Solomon appears not to have done much securities work, but does have a lot of trial experience in fraud, money laundering, and bribery matters, which will put him in good stead for his new job.  Chief Litigation Counsel Matt Martens has been shouldering the leadership role in the trial unit alone since Mark Adler left for the PCAOB in December 2010, so I imagine he welcomes the help.
  • Short-selling Australian hedge fund manager John Hempton makes interesting points about discovering fraud and why it is against his own interests to tip the SEC and other regulators to the subjects of his trades.  Briefly, he doesn’t want to tip regulators to frauds in the making because (1) he can profit from them if they are allowed to go on until his short positions are covered, and (2) he does not want to alert the SEC to odd but honest activity in the small number of cases where he’s wrong about the fraud.  The piece is actually pretty complimentary about the recent work of Mary Schapiro’s SEC.
  • Where are the Congressional hearings on the SEC’s neither-admit-nor-deny policy?  Some in Congress made a lot of noise about this last December.  Have they lost steam and moved on to other things?
  • On Monday, the SEC charged an online brokerage and a clearing agency specializing in options and futures with participating in an abusive naked short selling scheme.   Here is how short selling works, as John Hempton explained to his son in the piece linked above:  “I borrow a share from a broker. I sell it in the market. If the stock goes down I get to buy it back for less than I sold it. I repay the loan by returning the share and I keep the profit. I explained it does not work so well when the stock goes up.”  All of this is perfectly legal, but to be so, Regulation SHO requires the trader has to do two things: (1) locate actual shares to borrow, and (2) deliver the borrowed shares to the counterparty three days after the trade is completed (aka T + 3, in trading parlance).   If no delivery is made by that time, the trader 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 Enforcement Division’s Market Abuse unit alleged that Chicago-based optionsXpress failed to satisfy its close-out obligations under Reg. 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 an quantity.  According to the SEC, the firm and customer Jonathan I. Feldman engaged in these sham reset transactions in a number of securities, resulting in continuous failures to deliver.  As we’ll see below, the SEC was not through with optionsXpress for the week.
  • Also on Monday, the Southern District of Florida entered a judgment enforcing an SEC administrative order suspending William J. Reilly, a New York attorney residing in Boca Raton, Florida, from appearing or practicing as an attorney before the SEC.  In October 2009, Reilly was suspended for three years under Rule 102(e) of the Commission’s Rules of Practice for his participation in a penny stock scheme.  In July 2011, though, a legal opinion letter authored by Reilly appeared as an exhibit in a registration statement on Form S-8.  Someone at the SEC noticed, and the Enforcement Division sought to enforce the order in December 2011.
  • On Thursday, the SEC sued optionsXpress again in an administrative proceeding again, this time for continuing trading operations after delisting from the Chicago Board Options Exchange and deregistering from the SEC, apparently to avoid an audit, according to the SEC’s press release.
  • Finally, credit rating agency Egan-Jones announced that the SEC had voted to take enforcement action against it for allegedly material misstatements made in a regulatory application in 2008.  The agency appears to be taking a combative stance toward the action.  Because it is an administrative proceeding, any contested hearing will happen quickly.  It will not drag on with much discovery like a case in federal court would.

That’s all for today.  Have a good weekend.