Articles Posted in Short Selling

The Securities and Exchange Commission is accusing optionsXpress, a Charles Schwab Corp. (SCHW) subsidiary, of being involved in a naked short selling scheme between 2008 and 2010. The SEC filed an administrative order against the online futures and options brokerage and clearing agency, its CEO, and a client while settling with three other company officials. OptionsXpress didn’t come under Schwab’s ownership until 18 months after the alleged securities fraud occurred.

According to the Commission’s Division of Enforcement, the Chicago-based online futures and options brokerage and clearing agency did not meet its obligations under Regulation SHO because it repeatedly took part in a number of fake “reset” transactions that were created to make it appear as if the financial firm had bought securities of “like kind and quality.” CEO/CFO Thomas Stern, who is also named in the order, is accused of taking part in these transactions that resulted in a “continuous failures to deliver” securities to a clearing agency. Such alleged actions violate Commission rules because the SEC mandates that in most cases securities reach a clearinghouse within three days after a trade happens. Otherwise, the brokerage must borrow or buy the security so that the position is closed out by the start of the next trading day at the latest.

The alleged naked short-selling scam occurred when optionsXpress facilitated its customers’ buying of shares while at the same time selling deep-in-the-money call options that were pretty much the economic equivalent of selling shares short. Buying the shares made it appear as if the financial firm had fulfilled its close-out duty when, in fact, the shares that were purportedly bought in the reset transactions were never sent to the buyers because on the day that they were “purchased,” the deep-in-the money calls that occurred caused the shares to be effectively resold. Also, the reset transactions were not actual purchases because they were for perpetuating an open short position while making it appear as if Reg. SHO’s delivery and close out requirements were being met. As a result, optionsXpress and its clients were able to take part in a stock-kiting scheme that kept true stock purchasers from experiencing the benefits of ownership.

One optionsXpress customer, Jonathan I. Feldman, is also named in the SEC’s administrative order. He is accused of taking part in a number of these fake transactions involving several securities. For example, in 2009, he purchased $2.9 billion in securities while selling short at least $1.7 billion of options using his optionsXpress account.

OptionsXpress and Feldman intend to fight the SEC’s administrative order.

Meantime, optionsXpress trading and customer service head Peter Bottini and compliance officers Kevin Strine and Phillip Hoeh have settled the SEC’s allegations against them over the alleged naked short selling scheme. They are accused of knowing (or if they didn’t that they should have known) that the omissions or actions they committed contributed to optionsXpress violating Reg SHO. By settling, they are not denying or admitting to any wrongdoing.

Read the SEC’s administrative order (PDF)

SEC Charges OptionsXpress in Naked Short Selling Scheme, AdvisorOne, April 16, 2012

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Fontana Capital LLC Founder Violated Short-Selling Rule, Says SEC, Stockbroker Fraud Blog, February 2, 2011

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The U.S. Securities and Exchange Commission has charged Forrest Fontana with violating Rule 105 of Regulation M and illegally making more than $1 million. The rule prohibits investors from taking part in public offerings when they have shorted the same securities. Fontana, who allegedly violated the rule three times, helped investors make the unlawful profits.

The SEC contends that in 2008, the ex-hedge fund manager and founder of Fontana Capital LLC, allegedly shorted 60,000 shares of XL Capital (now XL Group) and then shorted 40,000 shares of Bank of America‘s Merrill Lynch (BAC). On July 29, 2008, regulators claim that Fontana bought 50,000 shares of XL Capital and 200,000 shares of Merrill Lynch in secondary offerings. He made $149,000 off his XL capital bets and $792,000 from Merrill Lynch. Later that year, he allegedly shorted 100,000 Wells Fargo (WFC) shares. Fontana bought the same amount the next day and made a profit of about $160,000.

Under the 1933 Securities Act, Rule 105 of Regulation M is there to prevent short selling that can decrease proceeds for shareholders and companies by artificially depressing a stock’s market price right before a company prices its public offering. Rule 105 of Regulation is there to make sure that offering prices are established through the natural forces of supply and demand. Traders must wait five days after shorting a stock before they can take part in that company’s public offering. This prevents investors from using shorting to lower the price that they will pay later in the offering.

There will be a hearing to determine the veracity of the allegations against Fontana and whether sanctions should be issued.

Related Web Resources:
SEC Accuses Fontana Capital of Breaching Short-Sale Restrictions, Bloomberg, January 7, 2011
Hedge fund manager faces SEC allegations,, January 8, 2011
Read the SEC’s administrative order (PDF)
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