Judge Orders Disgorgements, Fines in Naked Short Selling Matter
June 24, 2013
A U.S. Securities and Exchange Commission (SEC) judge ruled against optionsXpress Inc., former optionsXpress chief financial officer Thomas Stern, and former Maryland banker Jonathan Feldman in an alleged short selling scheme. The SEC accused Mr. Feldman of using optionsXpress to engage in so-called "naked short selling," a process of selling stock short without following through to borrow or deliver the shares in question. The agency claimed that Mr. Feldman perpetuated the "fail to deliver" of stock by continuously engaging in a series of deep in-the-money "buy-writes" in which the calls generally would be assigned immediately, given that the stocks were hard to borrow. The SEC also claimed that optionsXpress, a brokerage firm owned by Charles Schwab Corp., failed to satisfy its closeout obligations in these transactions.
An Analysis Group team led by Vice Presidents Lauren Kindler and Eric Dufresne supported options trading expert Brendan Sheehy, formerly of PEAK6 Investments LLP, who filed a report in this proceeding. In Mr. Sheehy's report, he examined trading records, evaluated and described trading strategies, and discussed the economic aspects of the transactions at issue. He opined that Mr. Feldman was trying to take advantage of the reversal/conversion market, which directly implies the fee to borrow stock. "When the borrowing fee is very high, the short rate will be a large negative rate," Mr. Sheehy wrote in his report. Without ever having to deliver shares and pay the negative borrow rate, Mr. Feldman was able to capture the fee to borrow stock as profits. In her decision, Chief Administrative Law Judge Brenda P. Murray wrote, "I accept as valid Sheehy's analysis of data for the period September 16, 2009, through March 21, 2010, which shows Feldman engaged in huge transactions that followed the same pattern and resulted in consistent assignments and buy-writes." Judge Murray ruled in favor of the SEC on all counts. She ordered Mr. Feldman to disgorge $2.7 million in profits and pay a $2 million civil fine; optionsXpress to disgorge $1.6 million and pay a $2 million civil fine; and Mr. Stern to pay a $75,000 civil fine and be barred from participation in the securities industry.