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Former San Diego Officials Agree to Pay Financial Penalties in Municipal Bond Fraud Case
FOR IMMEDIATE RELEASE
2010-204
Washington, D.C., Oct. 27, 2010 — The Securities and Exchange Commission today announced that four former San Diego officials have agreed to pay financial penalties for their roles in misleading investors in municipal bonds about the city's fiscal problems related to its pension and retiree health care obligations.
It's the first time that the SEC has secured financial penalties against city officials in a municipal bond fraud case.
The SEC settlement with the four former city officials requires the approval of U.S. District Judge Dana M. Sabraw in the Southern District of California.
The SEC filed charges in April 2008 against former San Diego City Manager Michael Uberuaga, former Auditor & Comptroller Edward Ryan, former Deputy City Manager for Finance Patricia Frazier, and former City Treasurer Mary Vattimo. The SEC alleged that the officials knew the city had been intentionally under-funding its pension obligations so that it could increase pension benefits but defer the costs. They also were aware that the city would face severe difficulty funding its future pension and retiree health care obligations unless new revenues were obtained, benefits were reduced, or city services were cut. However, despite this extensive knowledge, they failed to inform municipal investors about the severe funding problems in 2002 and 2003 bond disclosure documents.
"Municipal officials have a personal obligation to ensure that investors are provided with complete and accurate information about the issuer's financial condition," said Rosalind Tyson, Director of the SEC's Los Angeles Regional Office. "These former San Diego officials are paying a price for their actions that jeopardized the interests of investors and put the city's current and future retirees at risk."
The four former officials agreed to settle the SEC's charges without admitting or denying the allegations and consented to the entry of final judgments that permanently enjoin them from future violations of Securities Act of 1933 Section 17(a)(2). Under the settlement terms, Uberuaga, Ryan, and Frazier each pay a penalty of $25,000 and Vattimo pays a penalty of $5,000.
The SEC's charges against a fifth former city official — Assistant Auditor & Comptroller Teresa Webster — are still pending.
The SEC litigation was handled by John M. McCoy III, David J. Van Havermaat, and Catherine W. Brilliant.
# # #
For more information about this enforcement action, contact:
John M. McCoy, III
Associate Regional Director, SEC's Los Angeles Regional Office
(323) 965-4561
David J. Van Havermaat
Senior Trial Counsel, SEC's Los Angeles Regional Office
(323) 965-3866
http://www.sec.gov/news/press/2010/2010-204.htm
SEC alleges Office Depot made selective disclosure
WASHINGTON (MarketWatch) - Office Depot Inc. executives selectively shared information with analysts and its largest shareholders, giving some an unfair advantage, the Securities and Exchange Commission said Thursday after launching enforcement actions against the retailer and CEO Stephen A. Odland and then-CFO Patricia A. McKay for violating fair disclosure regulations. "Office Depot executives selectively shared information with analysts and the company's largest shareholders in order to manage earnings expectations," said SEC Division of Enforcement Director Robert Khuzami. "This gave an unfair advantage to favored investors at the expense of other investors and, as today's action shows, is illegal." The SEC alleged the pair directed investor relations officials to manage down their guidance for the second quarter of 2007.
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SEC Charges Georgia-Based Hedge Fund Managers With Fraud in Valuing a "Side Pocket" and Theft of Investor Assets
FOR IMMEDIATE RELEASE
2010-199
Washington, D.C., Oct. 19, 2010 — The Securities and Exchange Commission today charged two hedge fund portfolio managers and their investment advisory businesses with defrauding investors in the Palisades Master Fund, L.P. by overvaluing illiquid fund assets they placed in a "side pocket." The SEC alleges that the hedge fund managers also stole investor money to pay for their own personal investments and made material misrepresentations in connection with a private securities transaction.
Additional Materials
* SEC Complaint
* Litigation Release No. 21699
The SEC alleges that Paul T. Mannion, Jr., of Norcross, Ga., and Andrews S. Reckles of Milton, Ga., placed the Palisades hedge fund's investments in World Health Alternatives Inc. in a side pocket and valued those investments in a manner that was inconsistent with fund policy and contrary to an undisclosed internal assessment. A side pocket is a type of account that hedge funds use to separate particular investments that are typically illiquid from the remainder of the investments in the fund. The SEC's Asset Management Unit has been probing whether funds have overvalued assets in side pockets while charging investors higher fees based on those inflated values.
The SEC further alleges that Mannion and Reckles stole more than approximately $1.6 million worth of warrants belonging to the fund. They also improperly used investors' cash on at least two occasions to make personal investments, and they deceived a securities issuer by making false representations about their trading positions in order to participate in a private offering by the issuer.
"Mannion and Reckles put their own selfish interests ahead of Palisades' investors, treating the fund like their own personal bank account by stealing and improperly borrowing millions of dollars in fund assets," said Scott W. Friestad, Associate Director of the SEC's Division of Enforcement.
Robert B. Kaplan, Co-Chief of the SEC's Asset Management Unit, added, "Side pockets are not supposed to be a dumping ground for hedge fund managers to conceal overvalued assets. Mannion and Reckles deceived investors about the fund's performance and extracted excessive management fees based on the inflated asset values in a side pocket."
According to the SEC's complaint filed in the U.S. District Court for the Northern District of Georgia, Mannion and Reckles defrauded investors for at least a three-month period in 2005 through PEF Advisors LLC and PEF Advisors Ltd., two investment adviser entities they controlled. The fraudulent valuations of a convertible debenture, restricted stock, and bridge loans enabled Mannion and Reckles to report to investors misleadingly inflated net asset values, allowing them to take excessive management fees from the fund.
The SEC's complaint alleges that Mannion and Reckles stole more than one million warrants in World Health that belonged to the fund. At the time Mannion and Reckles exercised those warrants, they were worth $1.6 million. In July 2005, Mannion and Reckles took an undisclosed $2 million from the fund as an apparent short-term loan to finance their personal investments. They separately used approximately $13,000 from the fund to pay for services not rendered to the fund.
According to the SEC's complaint, Mannion and Reckles also made material misrepresentations in connection with a PIPE (private investment in public equity) offering conducted by Radyne ComStream Inc. in February 2004.
The SEC complaint charges defendants with violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and Sections 206(1) and 206(2) of the Investment Advisers Act of 1940. The Commission seeks injunctive relief, disgorgement of profits, prejudgment interest, and financial penalties.
The SEC's investigation was conducted by Adam S. Aderton and Julie M. Riewe of the Enforcement Division's Asset Management Unit under the leadership of co-chiefs Robert B. Kaplan and Bruce Karpati. The SEC's litigation effort will be led by David Williams.
# # #
For more information about this enforcement action, contact:
Scott W. Friestad
Associate Director, Division of Enforcement
202-551-4962 begin_of_the_skype_highlighting 202-551-4962 end_of_the_skype_highlighting
Robert B. Kaplan (202-551-4969 begin_of_the_skype_highlighting 202-551-4969 end_of_the_skype_highlighting) and Bruce Karpati (212-336-0104 begin_of_the_skype_highlighting 212-336-0104 end_of_the_skype_highlighting)
Co-Chiefs of the SEC Asset Management Unit
Julie M. Riewe
Assistant Director, Asset Management Unit
202-551-4546 begin_of_the_skype_highlighting 202-551-4546 end_of_the_skype_highlighting
# # #
http://www.sec.gov/news/press/2010/2010-199.htm
SEC Charges Two Florida-Based Fund Managers With Facilitating Petters Ponzi Scheme
FOR IMMEDIATE RELEASE
2010-195
Washington, D.C., Oct. 14, 2010 — The Securities and Exchange Commission today charged two Florida-based hedge fund managers and their firms with fraudulently funneling more than a billion dollars of investor money into a Ponzi scheme operated by Minnesota businessman Thomas Petters.
Additional Materials
* SEC Complaint
* Litigation Release No. 21694
The SEC alleges that Bruce F. Prévost of Palm Beach Gardens and David W. Harrold of Del Ray Beach falsely assured their investors and potential investors that the flow of their money would be safeguarded by collateral accounts and described a phony process for protecting their assets. When Petters was unable to make payments on investments held by the funds they managed, Prévost, Harrold, and their firms concealed it from investors by concocting sham note exchange transactions with Petters, who the SEC charged last year along with an Illinois-based hedge fund manager who also facilitated the scheme.
"Prévost and Harrold portrayed themselves as guardians of their hedge fund investors while in fact they facilitated Tom Petters's fraudulent scheme through lies and deceit," said Robert Khuzami, Director of the SEC's Division of Enforcement. "Their betrayal cost investors more than one billion dollars, while they pocketed millions in fees."
The SEC's complaint filed in U.S. District Court for the District of Minnesota alleges that Prévost, Harrold, and their firms Palm Beach Capital Management LP and Palm Beach Capital Management LLC invested more than $1 billion in hedge fund assets with Petters while pocketing more than $58 million in fees. Petters promised investors that their money would be used to finance the purchase of vast amounts of consumer electronics by vendors who then re-sold the merchandise to such "Big Box" retailers as Wal-Mart and Costco. In reality, Petters's "purchase order inventory financing" business was merely a Ponzi scheme. There were no inventory transactions. Petters sold promissory notes to feeder funds like those controlled by Prévost, Harrold, and their firms, and Petters used some of the note proceeds to pay returns to earlier investors, diverting the rest of the cash to his own purposes.
According to the SEC's complaint, Prévost, Harrold, and their firms funneled money into the Petters Ponzi scheme beginning as early as 2004 through at least June 2008. Prévost and Harrold sold interests in their Palm Beach Funds to individuals, foundations, family trusts and other hedge funds throughout the U.S. The Palm Beach Funds invested all investor contributions into the Petters Ponzi scheme and were holding more than $1 billion worth of notes when the scheme collapsed.
The SEC alleges that Prévost, Harrold, and their firms falsely assured investors that the inventory financing transactions were structured in such a way that after the retailers received their merchandise from vendors, they were supposed to send their payments for the merchandise directly into the funds' collateral accounts to pay off the notes held by the funds. This arrangement purported to protect investors inasmuch as the receipt of funds directly from the retailers would ostensibly verify their participation in each transaction. But in reality, money for the repayment of notes held by the funds always came directly from Petters and never came from any retailers. Prévost and Harrold did not disclose this material fact to investors in the funds, and instead continued to lie about the operation of the collateral accounts.
The SEC further alleges that Prévost, Harrold, and their firms devised with Petters a series of bogus note exchange transactions beginning around February 2008. The Palm Beach Funds on multiple occasions exchanged groups of mature notes that were due to be repaid on or about the date of the exchange for newly-issued notes that were not due to be paid for six months and purported to be collateralized by different merchandise associated with different inventory finance transactions. Instead of receiving cash repayments and then reinvesting that cash in new notes as they had done in the past, Prévost and Harrold simply began exchanging old IOUs for new ones, ultimately swapping the vast majority of notes held by the funds. Meanwhile, they continued to falsely report in monthly communications to investors that the funds were generating the same steady profits they had generated since their inceptions. These overstated rates of return resulted in the payment of excessive fees to Prévost, Harrold, and their firms.
The SEC's complaint charges Prévost, Harrold, and their firms with violations of Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and Sections 206(1), 206(2) and 206(4) of the Investment Advisers Act of 1940 and Rule 206-4(8) thereunder. The SEC seeks entry of a court order of permanent injunction against Prévost, Harrold, and their firms, as well as an order of disgorgement, including prejudgment interest and financial penalties.
Andrew P. O'Brien, Donald A. Ryba, Barry Isenman and Peter K.M. Chan of the SEC's Chicago Regional Office conducted the SEC's investigation. The SEC's litigation will be led by Daniel J. Hayes and John E. Birkenheier. The SEC's investigation is continuing.
# # #
For more information about this enforcement action, contact:
Timothy L. Warren
Associate Regional Director, SEC's Chicago Regional Office
(312) 353-7394 begin_of_the_skype_highlighting (312) 353-7394 end_of_the_skype_highlighting
Peter K.M. Chan
Assistant Regional Director, SEC's Chicago Regional Office
(312) 353-7410 begin_of_the_skype_highlighting (312) 353-7410 end_of_the_skype_highlighting
http://www.sec.gov/news/press/2010/2010-195.htm
SEC Warns of Potential Investment Scams Targeting Recipients of BP Oil Spill Payouts
FOR IMMEDIATE RELEASE
2010-193
Washington, D.C., Oct. 13, 2010 — The Securities and Exchange Commission is alerting individuals and small businesses about potential investment frauds targeting those who receive lump sum payouts from BP due to the oil spill in the Gulf.
The SEC’s investor alert says that scam artists may target payout recipients with oil spill-related investment opportunities that promise high returns with little or no risk, or involve secretive or complex strategies. Members of religious or ethnic communities, professional organizations or other close-knit affinity groups could be likely targets for these scams because of the high level of trust that often exists within these groups and their tendency to share information with one another.
The SEC’s investor alert suggests steps that individuals can take to avoid fraud, such as asking extensive questions and double-checking answers with an unbiased source. It also contains tips and resources for deciding how to use a lump sum payout. The SEC also has begun working with public libraries near BP claims centers to distribute a special package of financial education materials to Gulf residents.
“We have seen firsthand how recipients of highly publicized payouts can become targets for investment fraud,” said SEC Chairman Mary L. Schapiro. “In addition to our education efforts, we are on the lookout for any securities scams in the Gulf area attempting to defraud individuals, families, and businesses who already are financially strapped.”
After Hurricane Katrina, many scams targeted individuals receiving compensation from insurance companies. These scams took a number of forms, including trading programs falsely guaranteeing high returns, promoters touting companies purportedly involved in clean-up efforts, as well as classic Ponzi schemes.
“We are working with public libraries to provide BP payout recipients and other Gulf residents with the information they need to invest wisely and avoid fraud,” said Lori J. Schock, Director of the SEC’s Office of Investor Education and Advocacy.
The SEC’s Invest Wisely materials for Gulf residents include educational brochures and other helpful information for library patrons. Librarians can order a free sample folder by contacting Frank Locker, a librarian in the SEC Office of Investor Education and Advocacy, at (202) 551-6318 begin_of_the_skype_highlighting (202) 551-6318 end_of_the_skype_highlighting or LibraryOutreach@sec.gov. Members of the public also can order folders for themselves, family and friends.
# # #
http://www.sec.gov/news/press/2010/2010-193.htm
SEC Halts Web-Based Scheme Defrauding Deaf Investors
FOR IMMEDIATE RELEASE
2010-184
High-Res Photo
View high-resolution photo of Kenneth D. Israel, Director, SEC Salt Lake Regional Office
“Imperia's operators took proactive steps to conceal their identity by using an anonymous browser to host its website, communicating with all investors via e-mail, and taking their payments through off-shore PayPal-style bank accounts.”
Kenneth D. Israel
Director, SEC Salt Lake
Regional Office
Washington, D.C., Oct. 7, 2010 — The Securities and Exchange Commission has charged an Internet-based investment company with securities fraud for soliciting several million dollars from U.S. investors and promising them guaranteed returns of 1.2 percent per day while in reality siphoning the funds into foreign bank accounts and not paying a single penny back to investors.
Additional Materials
* SEC Complaint
* Litigation Release No. 21686
The SEC has obtained an emergency court order freezing the assets of Imperia Invest IBC, which allegedly raised more than $7 million from approximately 14,000 investors worldwide. More than half the funds were collected from U.S. investors who are members of the Deaf community. Imperia offered the investment opportunity through its website by touting such lucrative examples as a $50 investment turning into a $134,000 return in six months. Imperia's website stated that investors could only access their profits by purchasing a Visa debit card from Imperia for a few hundred dollars. However, Imperia has no relationship with Visa and was using the Visa name without authorization. On its website, Imperia has listed fake business addresses in both the Bahamas and Vanuatu.
"Imperia's operators took proactive steps to conceal their identity by using an anonymous browser to host its website, communicating with all investors via e-mail, and taking their payments through off-shore PayPal-style bank accounts," said Kenneth D. Israel, Director of the SEC's Salt Lake Regional Office. "Investors were promised eye-popping amounts of money in return for a simple $50 or $100 investment, and Imperia has made numerous excuses on its website about why these returns haven't been paid."
The SEC's complaint filed in U.S. District Court in Utah on October 6 alleges that Imperia is defrauding investors by soliciting funds via the Internet to purchase Traded Endowment Policies (TEP) — the British term for viatical settlements. A TEP or viatical settlement involves the sale of an insurance policy by the policy owner before the policy matures, and policies are sold at a discount from face value in an amount greater than the current cash surrender value. Imperia's website stated that an initial $50 investment would allow the investor to obtain an $80,000 loan from an unnamed foreign bank that would be used by Imperia to purchase a TEP. Imperia would then trade the TEPs and pay the investor a guaranteed return of 1.2 percent per day. While Imperia contends that its experience with financial derivatives and bank securities allows it to offer trading in TEPs to the mass market, no TEP purchases or trading appear to be taking place.
According to the SEC's complaint, the majority of investor funds were paid to Imperia through three PayPal-type entities located in Costa Rica, Panama, and the British Virgin Islands. Once the funds have been received from investors, Imperia apparently funnels these amounts and additional investor funds to bank accounts located in Cyprus and New Zealand. Meanwhile, investors are not receiving any returns. For example, one investor who invested $150 with Imperia received account statements from Imperia showing he had earned more than $36 million within a two-year time frame. Another individual who invested $500 in July 2007 received statements showing his account was worth nearly $44 million as of May 2010. Meanwhile, Imperia has made a range of excuses on its website about why investors have not received the astronomical returns they were promised. It initially claimed it could start paying investors only when it had at least 10,000 investors — a number that already has been significantly exceeded. Then Imperia claimed it experienced computer server problems during its "relocation" from the Bahamas to Vanuatu. Other purported reasons for delays in paying out investment proceeds have been the need for additional time to verify the identities of investors, and compromise of Imperia's computer system by hackers.
The emergency court order obtained by the SEC late yesterday on an ex parte basis freezes Imperia's assets and, among other things, grants expedited discovery and prohibits Imperia from destroying evidence. In addition to the emergency relief for investors, the SEC is seeking an injunction against future violations of the antifraud and securities registration provisions of the federal securities laws, disgorgement of ill-gotten gains with prejudgment interest, and financial penalties.
This matter was investigated by Jennifer Moore, Scott Frost and Matthew Himes of the SEC's Salt Lake Regional Office, and the litigation will be led by Daniel Wadley. The SEC appreciates the assistance of the State of Maine Office of Securities, the Securities Commission of the Bahamas, the Vanuatu Financial Services Commission, and the Cyprus Securities and Exchange Commission.
# # #
For more information about this enforcement action, contact:
Kenneth D. Israel
Regional Director, SEC's Salt Lake Regional Office
(801) 524-5796 begin_of_the_skype_highlighting (801) 524-5796 end_of_the_skype_highlighting
Karen Martinez
Assistant Director, SEC's Salt Lake Regional Office
(801) 524-5796 begin_of_the_skype_highlighting (801) 524-5796 end_of_the_skype_highlighting
http://www.sec.gov/news/press/2010/2010-184.htm
SEC Charges Internationally Syndicated Radio Show Host With Securities Fraud Scheme
FOR IMMEDIATE RELEASE
2010-186
High-Res Photo
View high-resolution photo of Marc J. Fagel, Director, SEC San Francisco Regional Office
“Alexander led investors to believe she would invest their money in secured real estate financing, but she and her cohorts merely used the money for their own benefit.”
Marc J. Fagel
Director
SEC San Francisco
Regional Office
Washington, D.C., Oct. 7, 2010 — The Securities and Exchange Commission today charged a talk radio show host and two other executives at a Monterey, Calif.-based firm with misappropriating $2.5 million of approximately $7 million they raised through the fraudulent sale of interests in two real estate investment funds.
Additional Materials
* SEC Complaint
* Litigation Release No. 21690
The SEC alleges that Barbra Alexander, the former president of APS Funding, used her status as host of an internationally-syndicated radio show for entrepreneurs called MoneyDots to lure investors who thought their money would be used to fund short-term loans secured by real estate. Alexander along with the firm's secretary/chief financial officer Beth Piña of Fairfield, Idaho, and vice president Michael E. Swanson of Seaside, Calif., instead stole investor money to pay themselves $1.2 million and finance MoneyDots and other unrelated businesses unbeknownst to investors. Alexander even used $200,000 of investor funds to remodel her kitchen.
"Alexander led investors to believe she would invest their money in secured real estate financing, but she and her cohorts merely used the money for their own benefit," said Marc J. Fagel, Director of the SEC's San Francisco Regional Office.
According to the SEC's complaint filed in federal district court in San Jose, Alexander, Piña and Swanson raised nearly $7 million from 50 investors for two investment funds managed by APS Funding. They claimed that the funds would make short-term secured loans to homeowners and yield 12 percent annual returns to investors. Contrary to what investors were told, $1.2 million of their money instead went directly to Alexander, Piña, and Swanson for personal use, and $1.3 million in investor funds was used to finance other businesses owned by Alexander and APS Funding, including MoneyDots.
The SEC further alleges that Alexander, Piña, and Swanson furthered the scheme by sending monthly account statements to investors reflecting fictitious profits and, in classic Ponzi scheme fashion, paying out purported returns that actually came from new investors.
The SEC's complaint charges Alexander, Piña, Swanson, and APS Funding with violating the antifraud provisions of the federal securities laws, and also charges Alexander, Swanson, and APS Funding with the unregistered sale of securities. The action seeks injunctive relief, disgorgement of ill-gotten gains, and monetary penalties.
In a related criminal proceeding announced today, the U.S. Attorney's Office for the Northern District of California filed criminal actions against Alexander, Piña, and Swanson based on the same alleged misconduct.
The SEC acknowledges the assistance of the U.S. Attorney's Office for the Northern District of California, the Federal Bureau of Investigation, and the Monterey County District Attorney's Office. Eric Brooks, Sheila O'Callaghan, and Cary Robnett of the SEC's San Francisco Regional Office conducted the SEC's investigation.
# # #
For more information about these enforcement actions, contact:
Marc J. Fagel
Director, SEC San Francisco Regional Office
(415) 705-2449 begin_of_the_skype_highlighting (415) 705-2449 end_of_the_skype_highlighting
Michael S. Dicke
Associate Director, SEC San Francisco Regional Office
(415) 705-2458 begin_of_the_skype_highlighting (415) 705-2458 end_of_the_skype_highlighting
http://www.sec.gov/news/press/2010/2010-186.htm
SEC Charges Purported Real Estate Business and Owner for Conducting Ponzi Scheme
FOR IMMEDIATE RELEASE
2010-185
High-Res Photo
View high-resolution photo of Merri Jo Gillette, Director, SEC Chicago Regional Office
“Investors were led to believe that their money was being safely invested in Anderson's real estate ventures.”
Merri Jo Gillette
Director, SEC Chicago
Regional Office
Washington, D.C., Oct. 7, 2010 — The Securities and Exchange Commission today charged a Chicago-area company and its owner for perpetrating a Ponzi scheme in which they promised investors extraordinary returns generated from a purportedly successful real estate business.
Additional Materials
* SEC Complaint
* Litigation Release No. 21688
The SEC alleges that Robert R. Anderson of Mt. Prospect, Ill., issued promissory notes through his company Rosand Enterprises that he claimed would generate investor returns ranging from 10 to 20 percent per month. Anderson misrepresented to investors that Rosand Enterprises purchased, constructed, rehabbed, and sold homes in the Chicago area and other locations. However, Anderson was not making any money in the real estate market and was instead conducting a Ponzi scheme to pay earlier investors with funds from new investors. He also helped himself to investor money to buy cars, make hefty credit card payments, and pay for his daughter's wedding.
"Investors were led to believe that their money was being safely invested in Anderson's real estate ventures," said Merri Jo Gillette, Director of the SEC's Chicago Regional Office. "Instead, he was paying investors in Ponzi-like fashion to keep his scheme afloat while also using their money for his personal expenses."
The SEC's complaint, filed in U.S. District Court in Chicago, alleges that Anderson raised approximately $12 million from at least 77 investors between approximately December 2005 and May 2008. Anderson told investors that Rosand Enterprises purchased and rehabilitated existing homes and constructed pre-fabricated modular homes. Anderson told investors that their returns were to be generated from the sale of the homes.
The SEC alleges that Anderson's representations were false and he did not use investor funds to construct or rehabilitate homes. Anderson invested $550,000 of the $12 million raised in a company that he did not control that, in turn, purchased a piece of commercial real estate that was not profitable and nearly all of the money that Rosand invested was lost. Rosand did not disclose the investment loss to investors.
According to the SEC's complaint, Anderson used approximately $7.9 million to make monthly "interest" and return of principal payments to investors, and he used approximately $1.9 million to invest in several suspicious offerings. He misused $632,000 to pay employees, independent contractors, and office expenses with investor funds. Anderson also illegally siphoned off $818,000 for his own and his family's personal expenses, including $326,000 for credit card payments, $142,000 on tuition and a wedding for his daughter, and $38,000 on cars.
The SEC's complaint charges Anderson and Rosand Enterprises with violations of the antifraud and registration provisions of the federal securities laws. The SEC is seeking a permanent injunction and disgorgement of ill-gotten gains with prejudgment interest, jointly and severally, against Anderson and Rosand and a financial penalty against Anderson.
The SEC coordinated the filing of these civil charges with the U.S. Attorney's Office for the Northern District of Illinois, which today announced criminal charges against Anderson.
Justin M. Delfino, Wilburn Saylor and Steven L. Klawans of the SEC's Chicago Regional Office conducted the SEC's investigation. The SEC's litigation will be led by Steven C. Seeger.
# # #
For more information about this enforcement action, contact:
Timothy L. Warren
Associate Director, SEC's Chicago Regional Office
(312) 353-7394 begin_of_the_skype_highlighting (312) 353-7394 end_of_the_skype_highlighting
Steven L. Klawans
Assistant Director, SEC's Chicago Regional Office
(312) 886-1738 begin_of_the_skype_highlighting (312) 886-1738 end_of_the_skype_highlighting
http://www.sec.gov/news/press/2010/2010-185.htm
SEC Charges Penny Stock Promoters in Series of Kickback Schemes
FOR IMMEDIATE RELEASE
2010-187
High-Res Photo
View high-resolution photo of Robert Khuzami, Director, SEC Enforcement Division
"These corrupt promoters meticulously planned their schemes down to the last detail, except for the possibility that they were walking into an undercover operation. This joint law enforcement effort is a stark warning to those who embark on securities fraud schemes that we may be listening and we may be watching."
Robert Khuzami
Director
SEC Enforcement Division
Washington, D.C., Oct. 7, 2010 — The Securities and Exchange Commission today charged more than a dozen penny stock promoters and their companies with securities fraud for their roles in various illicit kickback schemes to manipulate the volume and price of microcap stocks and illegally generate stock sales. One of the schemes was perpetrated by an actor who starred as a police officer on the long-running television show CHiPs.
Additional Materials
* SEC Complaint v. Wilcox, Mellone, Parsinia
* SEC Complaint v. Charbit and Korem
* SEC Complaint v. Sand and Ingen Tech
* SEC Complaint v. Galpern
* SEC Complaint v. Palmer and AccessKey
* SEC Complaint v. Epstein and Humphries
* Litigation Release No. 21691
The SEC worked closely with the U.S. Attorney's Office for the Southern District of Florida and the Federal Bureau of Investigation as the separate schemes were uncovered through FBI undercover operations conducted in such a way that no investors suffered harm. The U.S. Attorney today announced criminal charges against some of the same individuals facing SEC civil charges.
According to the SEC's complaints filed in U.S. District Court for the Southern District of Florida, the schemes generally involved the payment of kickbacks to purportedly corrupt pension fund managers or stockbrokers, who would use their clients' accounts to purchase the publicly traded stock of microcap issuers controlled or promoted by the individuals and companies charged today. What the promoters and insiders did not know was that the people with whom they arranged these illegal transactions were actually undercover FBI agents or confidential sources participating in undercover operations.
"These corrupt promoters meticulously planned their schemes down to the last detail, except for the possibility that they were walking into an undercover operation," said Robert Khuzami, Director of the SEC's Division of Enforcement. "This joint law enforcement effort is a stark warning to those who embark on securities fraud schemes that we may be listening and we may be watching."
Eric I. Bustillo, Director of the SEC's Miami Regional Office, added, "These penny stock promoters paid illicit kickbacks to people who they thought would help them profit at the expense of unsuspecting investors by manipulating the price of their stock or fraudulently selling their shares."
The SEC's complaints allege the following individuals and companies perpetrated various kickback schemes:
* Larry Wilcox, who lives in West Hills, Calif., and played Officer Jonathan "Jon" Baker on CHiPs, perpetrated interrelated kickback schemes with two other penny stock company executives. Anthony Mellone, who lives in Fort Lauderdale and was CEO of Tri-Star Holdings Inc., began the process by paying an illegal kickback to a purported employee pension fund trustee who was to purchase 40 million restricted shares of Tri-Star stock. Days later, Mellone paid another kickback for a purchase of 50 million restricted shares of stock. Unbeknownst to Mellone, the corrupt trustee and the trustee's business associate were undercover FBI agents, and another middleman was an FBI cooperating witness. Mellone, satisfied how the deal worked for his own company, sought to implement the same fraud with others. He informed Wilcox and Alex Parsinia of Calabasas, Calif., about the purportedly corrupt trustee, and both agreed to replicate the scheme for their own companies. Mellone demanded and received a $1,000 kickback from the witness for each completed restricted stock transaction he initiated. In each instance, the three attempted to conceal the kickback by entering into a consulting agreement with a phony company the trustee purportedly created to receive the kickback. Parsinia's company is Zcom Networks Inc. and Wilcox's company is The UC Hub Group.
* Jean R. Charbit and Tzemach David Netzer Korem engaged in a fraudulent kickback scheme to manipulate the stock of a microcap company so they could then sell their own shares at an artificially inflated price. Charbit, a stock promoter, paid an illegal kickback to a purported corrupt stock broker (actually an undercover FBI agent) to induce him to purchase $300,000 worth of stock in the microcap company for his clients' discretionary accounts. Korem drafted press releases for the penny stock company and served as its transfer agent through his company, First Public Securities Transfer. Korem, as the penny stock company's transfer agent, issued the stock certificate for the kickback. Charbit is a French citizen with a residence in Miami. Korem is believed to reside in Los Altos, Calif., and has several aliases. He also created a fictitious country, the Dominion of Melchizedek, which claims "ecclesiastical sovereignty" on an island in the South Pacific and has been the subject of criminal prosecutions in several countries.
* Scott R. Sand, the CEO and Chairman of Ingen Technologies, paid illegal kickbacks to an FBI undercover agent portraying an employee pension fund manager and to a cooperating witness portraying the manager's associate. The kickbacks were to induce the employee pension fund manager and his associate to purchase millions of restricted shares of Ingen stock. Sand also issued millions of shares of Ingen stock to the associate in exchange for acting as a middleman in the scheme. Sand told the purported manager and associate that he was trying to generate the appearance of market interest in his company, induce public purchases of its stock, and ultimately increase the stock's trading price. Sand lives in Calimesa, Calif.
* Jeffrey Galpern, a stock promoter who lives in Boca Raton, Fla., told a cooperating FBI witness that he held four million shares of stock in a Las Vegas-based microcap company and wanted to increase its value. Once the price spiked, Galpern planned to sell his own shares of the stock. He offered to promote the stock through a promotional website, and indicated that properly-timed press releases would sufficiently disguise any spike in trading volume by making it appear they were the reason behind it. Galpern intended to repeat the scheme at larger volumes and told the cooperating witness they could "continuously make money" through such a fraud.
* Bruce Palmer and his company AccessKey IP Inc. paid an illegal kickback of 30 million shares of restricted AccessKey stock to a purported corrupt stock broker (who was actually an undercover FBI agent) so he would purchase 90 million shares of AccessKey stock in order to generate the appearance of market interest in Palmer's company. Palmer attempted to conceal the kickback by issuing the shares to the broker's girlfriend and drafting three AccessKey press releases to provide a reason for the anticipated higher-than-normal trading volume created by the large purchase. Palmer did not know the broker's girlfriend was a fictional character created by the FBI. Palmer resides in Placitas, N.M.
* A pair of executives at Texas-based penny stock companies Earthworks Entertainment Inc. and The Fight Zone Inc. paid illegal kickbacks to a purported trustee of an employee pension fund so the trustee would purchase 40 million restricted shares of Earthworks and 200 million restricted shares of Fight Zone stock. John "Buckeye" Epstein and Steven E. Humphries attempted to conceal the kickback by entering into a consulting agreement with a phony company the trustee purportedly created solely for the fraud. However, the corrupt fund trustee and the trustee's friend who helped arrange the deal were actually undercover FBI agents. The company was actually a fictional entity created by the FBI for the sting operation. Epstein resides in Addison, Texas, and Humphries lives in Plano, Texas.
The SEC alleges that the promoters in some of the schemes understood that they needed to disguise the kickbacks as payments to phony consulting companies, which they knew would perform no actual work. In other instances, they knew that the purported corrupt fund managers and brokers would be violating their fiduciary duties to their clients by taking part in the kickback schemes.
The SEC's complaints allege the defendants violated Section 17(a) of the Securities Act of 1933, and Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934. The SEC is seeking permanent injunctions and financial penalties against all defendants; disgorgement plus prejudgment interest against defendants that received ill-gotten gains; officer-and-director bars against the individuals who served as officers or directors of the microcap companies involved; and penny stock bars against all individual defendants.
Jessica M. Weiner and Chedly C. Dumornay of the SEC's Miami Regional Office investigated the case, and James M. Carlson of the Miami office is litigating the actions. The SEC acknowledges the great assistance and cooperation of the U.S. Attorney's Office for the Southern District of Florida and the Federal Bureau of Investigation, Miami Division in investigating these matters.
# # #
For more information about this enforcement action, contact:
Glenn S. Gordon
Associate Regional Director, SEC's Miami Regional Office
(305) 982-6360 begin_of_the_skype_highlighting (305) 982-6360 end_of_the_skype_highlighting
Chedly C. Dumornay
Assistant Regional Director, SEC's Miami Regional Office
(305) 982-6377 begin_of_the_skype_highlighting (305) 982-6377 end_of_the_skype_highlighting
James M. Carlson
Senior Trial Counsel, SEC's Miami Regional Office
(305) 982-6328 begin_of_the_skype_highlighting (305) 982-6328 end_of_the_skype_highlighting
http://www.sec.gov/news/press/2010/2010-187.htm
SEC Charges Family Insider Trading Ring in Million-Dollar Scheme
FOR IMMEDIATE RELEASE
2010-178
Washington, D.C., Sept. 30, 2010 — The Securities and Exchange Commission today charged a pair of freight railway employees and four family members with perpetrating an insider trading scheme that garnered more than $1 million in illegal profits.
The SEC alleges that W. Gary Griffiths and Cliff M. Steffes learned confidential information in early 2007 about the upcoming acquisition of Florida East Coast Industries Inc. (FECI), which owned the freight railway where they worked in Jacksonville, Fla. Griffiths and Steffes tipped family members with the non-public information. The traders collectively purchased more than $1.6 million in company stock and options ahead of the May 8, 2007 announcement of the acquisition of FECI by an affiliate of Fortress Investment Group LLC.
Additional Materials
* SEC Complaint
* Litigation Release
"We allege these individuals exploited their personal and family relationships for monetary gain and that their misuse of confidential information gave them an illegal advantage over other traders in the market," said Merri Jo Gillette, Director of the SEC's Chicago Regional Office.
According to the SEC's complaint filed in U.S. District Court for the Northern District of Illinois, Griffiths is a resident of Elkton, Fla., and vice president and chief mechanical officer of Florida East Coast Railway. Steffes, who currently resides in Lisle, Ill., worked in the rail yard in Jacksonville when the insider trading scheme occurred.
The SEC alleges that in the weeks leading up to the impending acquisition of FECI, the two men tipped Rex C. Steffes, who is Steffes's father and Griffiths's brother-in-law, with the confidential information. Also tipped were the two brothers of Cliff Steffes — Bret Steffes and Rex R. Steffes — and his uncle Robert J. Steffes. The insider trading scheme generated more than $1 million in illicit profits after the acquisition of the company was announced publicly.
The SEC has charged the defendants with violating Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. Without admitting or denying the SEC's allegations, Robert J. Steffes has consented to a court order that would permanently enjoin him from violating Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder and require him to pay disgorgement of $104,981, prejudgment interest of $15,951 and a penalty of $104,981.
This case was investigated by Scott B. Tandy, Kent W. McAllister, Kevin R. Barrett, Rebecca Bernard, John J. Sikora, Jr. and Norman Jones in the SEC's Chicago Regional Office.
The SEC appreciates the assistance of the Financial Industry Regulatory Authority (FINRA) and the Chicago Board Options Exchange (CBOE) in this matter.
# # #
For more information about this enforcement action, contact:
Timothy L. Warren
Associate Director, SEC's Chicago Regional Office
312-353-7394 begin_of_the_skype_highlighting 312-353-7394 end_of_the_skype_highlighting
John J. Sikora, Jr.
Assistant Director, SEC's Chicago Regional Office
312-353-7418 begin_of_the_skype_highlighting 312-353-7418 end_of_the_skype_highlighting
http://www.sec.gov/news/press/2010/2010-178.htm
SEC Wins Fraud Trial Against Miami-Based Investment Companies and Their Owners
FOR IMMEDIATE RELEASE
2010-180
Washington, D.C., Oct. 1, 2010 — The Securities and Exchange Commission announced today that a federal judge has ruled in the SEC's favor in a trial against two Miami-based companies and three owners charged with fraudulently siphoning investor money through exorbitant, undisclosed commissions and fees in the sale of mutual funds.
U.S. Pension Trust Corp. and U.S. College Trust Corp. have been ordered by the Honorable Jose Martinez of the Southern District of Florida to pay more than $112 million. The three individuals running the companies — Iliana Maceiras, Leonardo Maceiras Jr., and Nildo Verdeja — have been ordered to pay more than $3.36 million combined.
Additional Materials
* Court Findings
The SEC charged the entities and individuals in September 2007 for defrauding approximately 14,000 investors in a 13-year scheme.
"Under the federal securities laws, investors are entitled to full disclosure so they know how much of their investment is going toward commissions and fees. The outcome of this case makes that point loud and clear," said Eric I. Bustillo, Director of the SEC's Miami Regional Office. "We will continue to aggressively pursue those who take investors' money and fail to give a full picture of how they are using those funds."
According to the court's findings, U.S. Pension Trust and U.S. College Trust solicited investments from mostly foreign investors in various multi-year investment plans starting in 1995. The plans put funds into a combination of U.S. mutual funds and insurance products. The court found that both in written materials provided to investors and in conversations that sales agents had with investors, the companies intentionally omitted disclosing numerous commissions and fees, including up to 85 percent of first-year contributions in some plans.
The court found that the companies and the individuals misrepresented to investors that their products were registered and regulated by the SEC, the Federal Reserve Bank, and the Office of the Comptroller of the Currency. The court also found that the defendants acted as broker-dealers in selling their products, without registering with the SEC.
The two companies were ordered to disgorge $62.6 million and pay a $50 million penalty. Each individual has been ordered to pay a $200,000 penalty in addition to disgorgement of their salaries during that time. Iliana Maceiras must disgorge $1,093,364. Leonardo Maceiras, Jr. must disgorge $674,567. Nildo Verdeja must disgorge $993,515.
In addition to the disgorgement and penalties, the court entered permanent injunctions against both companies and all three individuals against future violations of the securities laws.
In a related case, the same court entered a final judgment on Sept. 21, 2010 against Regions Bank — which served as trustee of U.S. Pension Trust and U.S. College Trust's plans from 2001 until 2009 — for its role in the offering fraud. The final judgment enjoined Regions Bank from violating the anti-fraud provisions of the federal securities laws and aiding and abetting violations of the broker-dealer registration provisions of the securities laws. Regions agreed to settle the charges without admitting or denying the allegations by consenting to the entry of the final judgment requiring payment of a $1 million penalty into a Fair Fund for the benefit of investors injured in U.S. Pension Trust and U.S. College Trust's offering fraud.
The SEC's case was litigated by senior trial counsels Amie Riggle Berlin and Scott Masel with the support of paralegal Patricia Soto and senior regional accountant Fernando Torres, who all work in the agency's Miami Regional Office.
# # #
For more information concerning this enforcement action, contact:
Eric I. Bustillo
Director, SEC Miami Regional Office
(305) 982-6300 begin_of_the_skype_highlighting (305) 982-6300 end_of_the_skype_highlighting
http://www.sec.gov/news/press/2010/2010-180.htm
SEC Charges Two Florida Companies and CEOs for Orchestrating Pump-and-Dump Schemes
FOR IMMEDIATE RELEASE
2010-176
Washington, D.C., Sept. 30, 2010 — The Securities and Exchange Commission today charged two Florida-based corporations and their CEOs for orchestrating two separate pump-and-dump schemes in which they issued numerous misleading press releases hyping their operations or services while their respective CEOs repeatedly sold their stock for significant profits.
Additional Materials
* Litigation Release No. 21674
* SEC Complaint
* Litigation Release No. 21675
* SEC Complaint
The SEC alleges that Quri Resources, Inc. and its CEO Jaime Santiago Gomez of Miami and Quito, Ecuador, issued misleading press releases for several months in 2009 falsely claiming that it was about to begin drilling on a mining project in Ecuador with a probable gold reserve worth more than $1 billion. The SEC separately charged Atlantis Technology Group and CEO Christopher Dubeau of Weston, Fla., for disseminating press releases over an eight-month period touting phony business relationships with television networks to sell their video and telecommunication services that did not even exist.
"Investors were duped into believing that Quri Resources was a successful mining company and that Atlantis Technology Group was selling cutting-edge technology services. Both companies misled investors with exaggerated claims while their respective senior executives illegally dumped shares into the market," said Eric I. Bustillo, Director of the SEC's Miami Regional Office. "We will continue to crack down on companies that promote misleading information."
According to the SEC's complaint filed in federal court in Miami against Quri Resources and Gomez, the misleading press releases were issued from at least February to July 2009. In addition to the false claims about the purported mining project, the SEC alleges that Quri misrepresented that it had signed letters of intent to acquire two valuable mining projects in Arizona, acquired a second mining project in Ecuador and anticipated producing gold within three months, and signed a letter of intent to acquire a third valuable mining project in Ecuador. The SEC further alleges that Gomez, who reviewed and approved the misleading press releases, repeatedly sold Quri stock in unregistered transactions as the press releases were being issued. Gomez made proceeds of approximately $17,500 in dumping the stock.
According to the SEC's complaint filed in federal court in Miami against Atlantis Technology Group and Dubeau, the Fort Lauderdale-based company issued misleading press releases from at least Aug. 7, 2009, to April 5, 2010. The SEC alleges that Atlantis falsely claimed that its subsidiary Global Online Television Corporation offered Internet protocol television (IPTV) services and video phone services to consumers, and had relationships with television networks to offer their content to subscribers. However, the subsidiary was not even in a position to offer IPTV or video phone services at that time, and Atlantis has never had any contract with a television network or any agreements to offer media content to customers.
The SEC further alleges that Dubeau drafted, reviewed, and approved Atlantis's misleading press releases while knowing that Atlantis did not have the capabilities or business relationships the press releases claimed. Meanwhile, Dubeau sold more than 60 million shares of Atlantis stock for proceeds of about $240,000, and he received $77,000 of the proceeds from an associate's sale of more than 16 million shares.
The SEC is seeking injunctions against further violations and the return of ill-gotten gains with prejudgment interest and financial penalties against Gomez and Dubeau. The SEC is additionally seeking an officer and director bar against Dubeau, and penny stock bars against Gomez and Dubeau.
The Quri Resources matter was investigated by Elizabeth Fatovich and Thierry Olivier Desmet in the SEC's Miami Regional Office. The Atlantis Technology matter was investigated by Mr. Desmet and Drew Panahi in the Miami office. Edward McCutcheon will be handling the litigation of both cases. The SEC appreciates the assistance of the Financial Industry Regulatory Authority (FINRA) in these matters.
# # #
For more information about these enforcement actions, contact:
Glenn S. Gordon
Associate Regional Director, SEC's Miami Regional Office
(305) 982-6300 begin_of_the_skype_highlighting (305) 982-6300 end_of_the_skype_highlighting
Thierry Olivier Desmet
Assistant Regional Director, SEC's Miami Regional Office
(305) 982-6300 begin_of_the_skype_highlighting (305) 982-6300 end_of_the_skype_highlighting
http://www.sec.gov/news/press/2010/2010-176.htm
Former State Street Employees Charged for Misleading Investors About Subprime Mortgage Investments
FOR IMMEDIATE RELEASE
2010-177
Washington, D.C., Sept. 30, 2010 — The Securities and Exchange Commission today charged a pair of former employees at Boston-based State Street Bank and Trust Company with misleading investors about their exposure to subprime investments.
The SEC's Division of Enforcement alleges that John P. Flannery and James D. Hopkins marketed State Street's Limited Duration Bond Fund as an "enhanced cash" investment strategy that was an alternative to a money market fund for certain types of investors. By 2007, however, the fund was almost entirely invested in subprime residential mortgage-backed securities and derivatives. Yet despite this exposure to subprime securities, the fund continued to be described as less risky than a typical money market fund and the extent of its concentration in subprime investments was not disclosed to investors.
Additional Materials
* SEC Order Against Flannery and Hopkins
The SEC charged State Street in a related case earlier this year. The firm agreed to settle the charges by repaying fund investors more than $300 million.
"Hopkins and Flannery misled State Street's investors about the risks and credit quality of a fund concentrated in subprime bonds and other subprime investments," said Robert Khuzami, Director of the SEC's Division of Enforcement. "The SEC is committed to identifying and holding accountable those who violated the law and harmed investors through subprime investments."
According to the SEC's order instituting administrative proceedings against Hopkins and Flannery, they played an instrumental role in drafting a series of misleading communications to investors beginning in July 2007. Flannery was a chief investment officer. Hopkins was a product engineer at the time, and later State Street's head of product engineering for North America.
According to the SEC's order, the misleading communications to investors related to the effect of the turmoil in the subprime market on the Limited Duration Bond Fund (established in 2002) and other State Street funds that invested in it. State Street provided certain investors with more complete information about the fund's subprime concentration and other problems with the fund. These better-notified investors included clients of State Street's internal advisory groups, which provided advisory services to some of the investors in the fund and the related funds.
The SEC's Division of Enforcement alleges that State Street's internal advisory groups, one of which reported directly to Flannery, subsequently decided to recommend that all their clients redeem from the fund and the related funds. The pension plan of State Street's publicly-traded parent company (State Street Corporation) was one of those clients. At the direction of Flannery and State Street's Investment Committee, State Street sold the fund's most liquid holdings and used the cash it received from these sales to meet the redemption demands of better informed investors. This left the fund and its remaining investors with largely illiquid holdings.
In the settlement with the firm announced jointly by the SEC and the offices of Massachusetts Secretary of State William F. Galvin and Massachusetts Attorney General Martha Coakley, State Street agreed to pay more than $300 million to investors who lost money during the subprime market meltdown in 2007. State Street distributed those funds to investors in February and March. State Street additionally paid nearly $350 million to investors to settle private lawsuits.
When the SEC announced its settlement with State Street in February, it also announced that State Street had agreed — pursuant to a limited privilege waiver — to provide information to enable the SEC to assess the potential liability of individuals involved with State Street's investor communications about the fund.
The SEC's case was investigated by Robert Baker, Cynthia Baran, Deena Bernstein, and John Kaleba. The SEC's litigation against Hopkins and Flannery will be led by Ms. Bernstein, Kathy Shields and Mr. Baker.
# # #
For more information about this enforcement action, contact:
David P. Bergers
Regional Director, SEC's Boston Regional Office
(617) 573-8927 begin_of_the_skype_highlighting (617) 573-8927 end_of_the_skype_highlighting
http://www.sec.gov/news/press/2010/2010-177.htm
SEC Charges Bay Area Investment Adviser for Not Disclosing Conflict of Interest to Investors
FOR IMMEDIATE RELEASE
2010-174
High-Res Photo
View high-resolution photo of Marc J. Fagel, Director, SEC San Francisco Regional Office
“Despite knowing that switching between funds would increase the costs to their clients, VCAM and Valentine did not fully disclose their conflicts in recommending the investment strategy.”
Marc J. Fagel
Director
SEC San Francisco Regional Office
Washington, D.C., Sept. 29, 2010 — The Securities and Exchange Commission today charged a Bay Area investment adviser with securities law violations for switching his clients between two related investments without informing them that the switch would boost the commissions they had to pay.
Additional Materials
* SEC's Order Against John Leo Valentine
The SEC found that San Ramon, Calif.-based Valentine Capital Asset Management (VCAM) and its principal John Leo Valentine failed to disclose material conflicts of interest when they advised clients to exchange one series of an investment fund for another series in the same fund. These moves had the effect of increasing the commission stream to VCAM and Valentine. VCAM and Valentine agreed to settle the SEC's case without admitting or denying the findings. They will return more than $400,000 in excess commissions to their clients and pay a $70,000 penalty.
"Investors are entitled to understand the fees they are being charged by their advisers and whether any conflicts of interest might be influencing the investment advice they are receiving," said Marc Fagel, Director of the SEC's San Francisco Regional Office. "Despite knowing that switching between funds would increase the costs to their clients, VCAM and Valentine did not fully disclose their conflicts in recommending the investment strategy."
According to the SEC's order instituting an administrative proceeding against Valentine and VCAM, Valentine advised his clients in mid-2005 to invest in Series A of a managed futures fund. Investors paid a 4 percent annual commission, which terminated in approximately 2½ years once an investor had paid 10 percent in total commissions. In December 2007, when many clients had reached or were close to reaching the 10 percent threshold after which they would no longer pay commissions, Valentine began advising clients to exchange at least some portion of their Series A holdings for Series B of the same fund — a largely identical investment but with higher leverage. But by making the switch, clients would have to restart the process of making the 4 percent annual commission payments. VCAM and Valentine did not clearly disclose this conflict of interest when advising clients to make a fund switch that would restart their commission charges.
The SEC's order finds that as a result of Valentine's recommendation, approximately 140 clients switched from Series A to Series B. The majority of those clients had reached or neared the 10 percent commissions cap. Therefore, this switching activity generated more than $400,000 in additional commissions for VCAM and Valentine.
The SEC's order finds that VCAM and Valentine breached their fiduciary duties to their advisory clients. In settling the case, VCAM and Valentine have agreed to cease and desist from violating Section 206(2) of the Investment Advisers Act of 1940 (an antifraud provision), receive censures, pay the $70,000 penalty, and return $400,000 in excess commissions to their clients.
Sahil W. Desai, Sheila O'Callaghan and Cary Robnett of the SEC's San Francisco Regional Office conducted the investigation.
# # #
For more information about this enforcement action, contact:
Marc J. Fagel
Regional Director, SEC's San Francisco Regional Office
(415) 705-2449 begin_of_the_skype_highlighting (415) 705-2449 end_of_the_skype_highlighting
Michael S. Dicke
Associate Regional Director, SEC's San Francisco Regional Office
(415) 705-2458 begin_of_the_skype_highlighting (415) 705-2458 end_of_the_skype_highlighting
http://www.sec.gov/news/press/2010/2010-174.htm
SEC Charges ABB For Bribery Schemes in Mexico and Iraq
FOR IMMEDIATE RELEASE
2010-175
High-Res Photo
View high-resolution photo of Scott W. Friestad, Associate Director, SEC Enforcement Division
“There are significant consequences for public companies that fail to implement strong compliance programs and prevent corrupt payments to government officials.”
Scott W. Friestad
Associate Director
SEC Enforcement Division
Washington, D.C., Sept. 29, 2010 — The Securities and Exchange Commission today charged ABB Ltd with violations of the Foreign Corrupt Practices Act (FCPA) for using subsidiaries to pay bribes to Mexican officials to obtain business with government-owned power companies, and to pay kickbacks to Iraq to obtain contracts under the U.N. Oil for Food Program.
Additional Materials
* SEC Complaint
* Litigation Release No. 21673
The SEC alleges that ABB's subsidiaries made at least $2.7 million in illicit payments in these schemes to obtain contracts that generated more than $100 million in revenues for ABB, a Swiss corporation that provides power and automation products and services worldwide.
ABB has agreed to pay more than $39.3 million to settle the SEC's charges.
"This investigation uncovered millions of dollars in bribes paid or promised to officials at Mexico's largest power company," said Scott W. Friestad, Associate Director of the SEC's Division of Enforcement. "As the sanctions in this case demonstrate, there are significant consequences for public companies that fail to implement strong compliance programs and prevent corrupt payments to government officials.
Cheryl J. Scarboro, Chief of the SEC's Foreign Corrupt Practices Act Unit, added, "ABB's violations involved conduct at a U.S. subsidiary and six foreign-based subsidiaries. Multi-national companies that make illicit payments through layers of subsidiaries will be held accountable."
The SEC's complaint filed in federal court in Washington, D.C., alleges that from 1999 to 2004, ABB Network Management (ABB NM) — a business unit within ABB's U.S. subsidiary — bribed officials in Mexico to obtain and retain business with two government owned electric utilities, Comision Federal de Electricidad (CFE) and Luz y Fuerza del Centro (LyFZ). The bribes were funneled through ABB NM's agent and two other companies in Mexico. The SEC alleges that ABB failed to conduct due diligence on these payments and entities and improperly recorded the bribes on its books as payments for commissions and services on projects in Mexico. Illicit payments included checks and wire transfers to relatives of CFE officials, cash bribes to CFE officials, and a Mediterranean cruise vacation for CFE officials and their wives. As a result of this bribery scheme, ABB NM was awarded contracts with CFE and LyFZ that generated more than $90 million in revenues and $13 million in profits for ABB.
The SEC alleges that from approximately 2000 to 2004, ABB participated in the U.N. Oil for Food Program through six subsidiaries that developed various schemes to pay secret kickbacks to the former regime in Iraq to obtain contracts under the program. ABB's Jordanian subsidiary acted as a conduit for other ABB subsidiaries by making the kickback payments on their behalf. Some of the kickbacks were made in the form of bank guarantees and cash payments. ABB improperly recorded these kickbacks on its books as legitimate payments for after sales services, consultation costs, and commissions. Oil for Food contracts obtained as a result of the kickback schemes generated $13.5 million in revenues and $3.8 million in profits for ABB.
Without admitting or denying the allegations in the SEC's complaint, ABB consented to the entry of a final judgment that permanently enjoins the company from future violations of Sections 30A, 13(b)(2)(A), and 13(b)(2)(B) of the Securities Exchange Act of 1934, orders the company to pay $17,141,474 in disgorgement, $5,662,788 in prejudgment interest, and a $16,510,000 penalty. The order also requires the company to comply with certain undertakings regarding its FCPA compliance program.
Brian O. Quinn, Tracy L. Price, and Denise Hansberry conducted the SEC's investigation. The Commission acknowledges the assistance of the Department of Justice's Criminal Division-Fraud Section, the Federal Bureau of Investigation, and the U.N. Independent Inquiry Committee.
# # #
For more information about this enforcement action, contact:
Cheryl J. Scarboro,
Chief, Foreign Corrupt Practices Act Unit, Division of Enforcement
202-551-4403 begin_of_the_skype_highlighting 202-551-4403 end_of_the_skype_highlighting
Scott W. Friestad
Associate Director, Division of Enforcement
202-551-4962 begin_of_the_skype_highlighting 202-551-4962 end_of_the_skype_highlighting
http://www.sec.gov/news/press/2010/2010-175.htm
SEC Charges Minneapolis Attorney and San Francisco Real Estate Lending Fund Promoters with Misleading Investors
FOR IMMEDIATE RELEASE
2010-170
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“Investors were entitled to know true facts rather than the misleading positive spin that Bozora, Redpath, and Duckson provided.”
Robert Burson
Senior Associate Regional Director, Chicago Regional Office
Washington, D.C., Sept. 21, 2010 — The Securities and Exchange Commission today charged a Minneapolis-based attorney and two San Francisco-area promoters with defrauding investors in a real estate lending fund by concealing the financial collapse of the fund's sole business partner.
Additional Materials
* SEC Complaint
The SEC alleges that Todd A. Duckson, an attorney who resides in Prior Lake, Minn., and Michael W. Bozora and Timothy R. Redpath, who reside in Marin County, Calif., raised more than $21 million from investors in the Capital Solutions Monthly Income Fund after the fund's sole business partner defaulted on its obligations to the fund. The SEC alleges that after this May 2008 default, the fund - whose sole business was to make real estate loans to a single borrower - had no meaningful income and was using new investor funds to pay existing investors.
"The fund's real estate lending strategy failed due to the collapse of the fund's sole borrower. Instead of disclosing this fact, Bozora, Redpath, and Duckson falsely claimed that the fund was positioned to profit from the U.S. real estate downturn," said Robert J. Burson, Senior Associate Regional Director of the SEC's Chicago Regional Office. "Investors were entitled to know true facts rather than the misleading positive spin that Bozora, Redpath, and Duckson provided."
The SEC alleges that after the default, Duckson, Bozora, and Redpath told investors that the fund was poised to take advantage of attractive lending opportunities provided by the collapse in the U.S. credit and real estate markets, when in fact the fund' s business strategy had failed.
According to the SEC's complaint filed in federal court in Minneapolis, Bozora and Redpath launched the fund in 2004 and, through August 2009, raised approximately $74 million from approximately 450 investors from across the U.S. After the May 2008 default by the fund's sole borrower, the fund foreclosed on the borrower's real estate projects. The SEC alleges that in late 2008, Bozora and Redpath asked Duckson, who was acting as the fund's outside counsel, to take over managing the fund. The SEC alleges that Duckson then began managing the fund while Bozora and Redpath continued to raise money from new investors. The SEC alleges that Bozora, Redpath, and Duckson failed to disclose the default and foreclosure to investors for several months.
The SEC alleges that Bozora, Redpath, and Duckson eventually made some disclosure of the default and foreclosure, but they minimized the impact of these events and continued to misleadingly promote the fund's ability to make new loans. In fact, the fund's ability to make new loans was limited. After the default and foreclosure, the fund was required to use most of its assets to maintain its existing real estate portfolio acquired through the foreclosure and to pay existing investors.
The SEC's complaint also charges True North Finance Corporation, a Minneapolis real estate lending company that merged with the fund in 2009, and True North's Chief Financial Officer Owen Mark Williams with accounting fraud. The SEC alleges that in 2008 and 2009, Williams caused True North to overstate its revenues by as much as 99 percent. The SEC alleges that True North improperly recognized revenue on interest from borrowers who were not paying True North and were in poor financial condition. The SEC further alleges that True North's recognition of revenue was contrary to its own revenue recognition policy, which stated that it would not recognize revenue where payment of interest was 90 days past due.
The SEC is seeking permanent injunctions, disgorgement, prejudgment interest and civil penalties against all of the defendants, and officer-director bars against Bozora, Redpath, Duckson, and Williams.
Marlene Key, Eric Phillips, and Wilburn Saylor of the SEC's Chicago Regional Office conducted the SEC's investigation. The SEC's litigation will be conducted by Ms. Key and Mr. Phillips.
# # #
For more information about this enforcement action, contact:
Robert J. Burson
Senior Associate Director, SEC's Chicago Regional Office
(312) 353-7428 begin_of_the_skype_highlighting (312) 353-7428 end_of_the_skype_highlighting
http://www.sec.gov/news/press/2010/2010-170.htm
From Chairman & CEO of the Pink Sheets
Dear OTC Investor:
I am writing to alert you of a very important rule change that is needed to improve the OTC marketplace. I need your help to make regulators turn on the lights and protect investors from the menace of hidden short selling in the OTC market.
I think you'll agree that this issue deserves the small amount of your time it will take for you to tell the SEC what you think about this issue.
As Chairman & CEO of the Pink Sheets, I know perhaps better than anyone the importance of improving the Pink Sheets and OTCBB trading. And I know the devastating impact that small companies face when their market is tarnished by the threat of manipulation.
There is a crisis facing the OTC market today in the lack of short sale position reporting and disclosure for OTC issues. This lack of transparency regarding short selling in the OTC market allows fraudulent acts to go undiscovered and manipulative short sellers to hide.
I believe regulators should fix the problem. Small issuers traded on the Pink Sheets and the OTCBB deserve the same transparency and regulatory oversight of short selling as those listed on Exchanges or NASDAQ.
Therefore, Pink Sheets has petitioned the SEC to cause the amendment of NASD Rule 3360 and require NASD broker dealers to maintain a record of total "short" positions in all customer and proprietary firm accounts in all publicly traded equity securities as well as report this information to the NASD for public dissemination of the short positions by security. The SEC's action is urgently needed to prevent fraudulent acts, expose market manipulation, promote fair principles of trade and protect investors.
Our full rule change request is available for you to read at: sec.gov/rules/petitions/petn4-500.pdf and comments by other concerned OTC market participants are available at: sec.gov/rules/petitions/4-500.shtml
But I cannot make this important rule change happen without your help. Thus I'm asking you to write a letter today, and voice your support to the SEC for the Pink Sheets' Request for Rulemaking Regarding Member Records of "Short" Positions and Reporting and Public Dissemination.
So please send your comments via Email to: rule-comments@sec.gov with a Cc: copy to: pubcom@nasd.com
Or, if it's more convenient, you can mail your comments to:
Jonathan G. Katz
Secretary, Securities Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
With a copy to:
Barbara Z. Sweeney
Senior Vice President and Corporate Secretary, NASD
1735 K Street, NW
Washington DC 20006-1500;
Either way, your Email or letter should refer to SEC File No. 4-500. Request for Rulemaking Regarding Member Records of "Short" Positions and Reporting and Public Dissemination of Aggregate Positions by Security.
I know I'm asking you to do a lot. But it's important that we make the OTC market transparent and fairly regulated. I think you'll agree that this issue deserves the small amount of your time to tell the SEC what you think about this issue.
Remember, the only way to succeed in achieving this rule change is through the public outcry of investors demanding the SEC make this needed improvement to the OTC markets, and there is no substitute for your personal voice in this debate. This important rule change is not going to happen if you remain silent.
So please, don't rely on others to get the job done. Write your Emails or letters today. Together, we must win this battle and convince the SEC not to treat the OTC secondary markets for small companies as second class citizens.
Without this rule change investors and securities regulators will be blind to any short selling activity in Pink Sheets and OTCBB stocks. The SEC needs to know that the lack of short sale information in your securities is unacceptable and demand they change NASD Rule 3360 immediately.
I'm asking for your help to improve this critical part of the securities market, so that companies like yours will be traded in transparent, efficient and well regulated OTC markets. Please do your part by writing your Email or letter today. Every voice counts in the debate, and yours could be the one that puts us over the top.
Thank you for your time and help in this fight.
Sincerely,
R. Cromwell Coulson
Chairman & CEO
P.S. We can only succeed in making these rule changes with your help. So please, take action today. And once again, thank you very much for your help.
Note: To comment to the SEC via Internet, use rule-comments@sec.gov with a Cc: copy to: pubcom@nasd.com
File No. 4-500. Request for rulemaking regarding member records of "short" positions and reporting and public dissemination of aggregate positions by security.
SEC Public Petition page: http://sec.gov/rules/petitions.shtml
Pink Sheets request is available at: http://sec.gov/rules/petitions/petn4-500.pdf
Comments by other concerned OTC market participants are available at: http://sec.gov/rules/petitions/4-500.shtml
http://www.otcmarkets.com/otcguide/issuers_shortsellingletter.jsp
SEC Proposes Measures to Enhance Short-Term Borrowing Disclosure to Investors
FOR IMMEDIATE RELEASE
2010-169
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Washington, D.C., Sept. 17, 2010 — The Securities and Exchange Commission today voted unanimously to propose measures that would require public companies to disclose additional information to investors about their short-term borrowing arrangements.
The SEC's proposal would shed a greater light on a company's short-term borrowing practices, including what some refer to as balance sheet "window-dressing." The proposed rules are aimed to enable investors to better understand whether amounts of short-term borrowings reported at the end of reporting periods are consistent with amounts outstanding throughout the reporting periods.
"Under these proposed rules, investors would have better information about a company's financing activities during the course of a reporting period — not just a period-end snapshot," said SEC Chairman Mary L. Schapiro. "Investors would be better able to evaluate the company's ongoing liquidity and leverage risks."
Many financial institutions and other companies engage in short-term borrowing in order to fund operations. These financing arrangements can range from commercial paper, repurchase agreements, letters of credit, promissory notes and factoring. They generally mature in a year or less.
The additional short-term borrowing disclosure information required under the proposed rules would be presented in the Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) section of a company's quarterly and annual reports.
The Commission also voted to issue an interpretive release that will provide guidance about existing requirements for MD&A disclosure about liquidity and funding.
Additional Materials
* Proposed Disclosure Requirements
* Interpretive Release
Public comments on the proposed rules should be received by the Commission within 60 days after their publication in the Federal Register.
# # #
FACT SHEET
Short-Term Borrowing and Existing Disclosure Obligations
In order to fund operations, many financial institutions and other companies engage in short-term borrowing — that is, a financing arrangement that generally matures in a year or less. Such borrowing arrangements have become increasingly common and can take many forms, including commercial paper, repurchase agreements, letters of credit, promissory notes and factoring.
Due to their short-term nature, a company's use of these kinds of financing arrangements can fluctuate significantly during a reporting period. As such, when a company reports at the end of a reporting period the amount of short-term borrowings outstanding, that amount is not always indicative of its funding needs or activities during the full period.
Currently, SEC rules require companies to disclose short-term borrowings at the end of the period. But there is no specific requirement to disclose information about the amount of short-term borrowings outstanding throughout the reporting period. The only exception is for bank holding companies, which must disclose annually the average and maximum amounts of short-term borrowings outstanding during the year. That means investors in bank holding companies can see whether the year-end amounts of short-term borrowings are lower or higher than amounts outstanding during the year. The SEC's current rules do not require comparable disclosure by other companies, nor do they require quarterly disclosure of average and maximum amounts by bank holding companies.
Investors who lack this information may not fully appreciate a company's liquidity, leverage position and funding risks. And, because there is no reporting requirement, concerns have been expressed that companies may be masking their actual liquidity and leverage position by incurring significant short-term borrowings during reporting periods and reducing those amounts just before period-end in order to show less leverage in their reported amounts.
Recent events have suggested that investors could benefit from additional transparency about companies' short-term borrowings, and, in particular, whether those borrowings vary materially during the reporting period as compared to period-end without investor appreciation of those variations.
The Proposed Rules
The proposed rules are designed to provide investors a better understanding of a company's actual funding needs and financing activities. They also will help investors evaluate the liquidity risks faced by companies during each reporting period.
Additionally, by providing transparency about variations in borrowing levels during the reporting period, the proposed disclosure requirements should help to address concerns that companies may mask their actual liquidity positions by reducing short-term borrowings shortly before reporting dates.
How does the proposed requirement define short-term borrowings?
*
"Short-term borrowings" would mean amounts payable for short-term obligations that are:
o Federal funds purchased and securities sold under agreements to repurchase.
o Commercial paper.
o Borrowings from banks.
o Borrowings from factors or other financial institutions.
o Any other short-term borrowings reflected on the registrant's balance sheet.
*
The proposed requirement is designed to enhance disclosure about the short-term borrowings line items in a company's balance sheet, and does not cover "off-balance sheet" financing arrangements. The SEC's existing disclosure rules cover off-balance sheet arrangements.
What would companies be required to disclose?
First, a company would be required to provide quantitative information in MD&A for each type of short-term borrowings a company uses, including:
*
The amount outstanding at the end of the reporting period and the weighted average interest rate on those borrowings.
*
The average amount outstanding during the period and the weighted average interest rate on those borrowings.
*
The maximum amount outstanding during the period.
Second, to provide context for the quantitative data, companies would be required to disclose:
*
A general description of the short-term borrowings arrangements included in each category and the business purpose of those arrangements.
*
The importance to the company of its short-term borrowings arrangements to its liquidity, capital resources, market-risk support, credit-risk support or other benefits.
*
The reasons for the maximum reported level for the reporting period.
*
The reasons for any material differences between average short-term borrowings and period-end short-term borrowings.
Would financial companies be subject to different disclosure requirements than non-financial companies?
Yes — the proposed requirements distinguish between companies that engage in financial activities as their business and all other companies:
*
Companies that are "financial companies" would be required to provide averages calculated on a daily average basis (which is consistent with existing guidance included in the SEC's bank holding company disclosure guide known as Guide 3), and to disclose the maximum amount outstanding on any day in the period.
*
All other companies would be permitted to calculate averages using an averaging period not to exceed a month and to disclose the maximum month-end amount during the period.
Which companies would meet the proposed definition of "financial company"?
The proposed rules would include a new category of companies that would be "financial companies" subject to the daily average computation requirement. The purpose of the new definition is to scope in companies beyond bank holding companies for which short-term borrowings may be a significant source of liquidity and for which liquidity and leverage information is especially important.
Under the proposal, the term "financial company" would mean a company, during the applicable reporting period, that is:
*
Engaged to a significant extent in the business of lending, deposit-taking, insurance underwriting or providing investment advice.
*
A broker or dealer as defined in Section 3 of the Exchange Act; or
*
An entity that is or is the holding company of, a bank, a savings association, an insurance company, a broker, a dealer, a business development company, an investment adviser, a futures commission merchant, a commodity trading advisor, a commodity pool operator, or a mortgage real estate investment trust.
How would a company that has both financial businesses and non-financial businesses be treated under the proposed rule?
A company that is engaged in both financial and non-financial businesses would be permitted to present the short-term borrowings information for its financial and non-financial businesses separately:
*
It would be required to provide averages computed on a daily average basis and maximum daily amounts for the short-term borrowings arrangements of its financial operations.
*
It would be permitted to follow the requirements and instructions applicable to non-financial companies for purposes of the short-term borrowings arrangements of its non-financial operations.
How do the proposed requirements address "repo" transactions?
*
Most repurchase arrangements (referred to as "repos") are accounted for as financings on the balance sheet. As such, most repos would be covered by the proposed short-term borrowings disclosure requirements.
*
If a repo is appropriately accounted for as a sale (and therefore is not reflected on the balance sheet as a liability), it must be assessed under the SEC's existing disclosure requirements for off-balance sheet arrangements. The SEC's existing rules require disclosure where the repo is reasonably likely to have an effect on the company that is material.
Details of MD&A Interpretive Release
The Commission also issued an interpretive release providing guidance on existing MD&A requirements for liquidity and funding disclosure. The guidance will be effective immediately upon publication in the Federal Register.
What issues are covered by the guidance?
The interpretive release will:
*
Reiterate long-standing MD&A principles as they apply to disclosure of critical liquidity matters, so that MD&A disclosure keeps pace with the increasingly diverse and complex financing alternatives available to companies.
*
Make clear that a registrant cannot use financing structures (whether "on-balance sheet" or "off-balance sheet") designed to mask the registrant's reported financial condition — transparent disclosure is required.
*
Emphasize that leverage ratios and other financial measures included in filings with the Commission must be calculated and presented in a way that does not obscure the company's leverage profile or reported results.
*
Address divergent practices that have arisen in the context of tabular disclosure of contractual obligations, to focus companies on providing informative and meaningful disclosure about their future payment obligations.
http://www.sec.gov/news/press/2010/2010-169.htm
SEC Charges Colorado-Based Investment Adviser With Fraudulently Recommending Hedge Funds to Older Investors
FOR IMMEDIATE RELEASE
2010-165
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“Greenberg's unsuitable recommendations and misrepresentations deceived his advisory clients into believing their money was safe with him.”
Donald M. Hoerl
Director, SEC Denver Regional Office
Washington, D.C., Sept. 7, 2010 — The Securities and Exchange Commission today charged Boulder, Colo.-based investment adviser Neal R. Greenberg with fraud and breach of fiduciary duty in the marketing and recommendation of his firm's hedge funds to investors, including many elderly clients.
Additional Materials
* SEC Order Against Neal R. Greenberg
The SEC's Division of Enforcement alleges that Greenberg falsely stated that the Agile hedge funds offered and managed by his two investment advisory firms were suitable for conservative investors who were retired or nearing retirement. However, the Agile hedge funds used leverage and concentrated in a small number of investments. The funds suffered substantial losses in September 2008 and ceased redemptions to investors. The SEC Division of Enforcement further alleges that the Agile hedge funds improperly collected approximately $2 million in management and performance fees that were not adequately disclosed to investors.
"Greenberg misrepresented the diversification, risks and fees involved with investing in the Agile hedge funds to conservative investors who were dependent upon their investment income for some or all of their living expenses," said Donald M. Hoerl, Director of the SEC's Denver Regional Office. "Greenberg's unsuitable recommendations and misrepresentations deceived his advisory clients into believing their money was safe with him."
According to the SEC's order instituting administrative and cease-and-desist proceedings against Greenberg, the Agile hedge funds held approximately $174 million of capital from more than 100 investors when Greenberg suspended redemptions in September 2008. Greenberg was the CEO of his investment advisory firm Tactical Allocation Services LLC that made investment recommendations to clients, and the head portfolio manager for his other investment advisory firm Agile Group LLC, which managed the Agile hedge funds.
The SEC's Division of Enforcement alleges that Greenberg falsely stated that the Agile hedge funds offered liquidity, immense diversification and minimal risk. He also falsely stated that the hedge funds could safely represent an investor's entire investment portfolio, and that they used leverage in a way that did not significantly increase the risk profile of the funds. The risk disclosures in private placement memoranda for the Agile hedge funds for 2007 and 2008 contradicted Greenberg's false and misleading verbal and written representations to investors.
According to the SEC's order, the majority of Greenberg's advisory clients were generally conservative, older investors who wanted low-risk investments offering significant capital protection. The Division of Enforcement alleges that Greenberg failed to ensure that adequate compliance policies and procedures were developed or implemented for determining when it would be suitable for advisory clients to invest in complex hedge fund products, particularly for unsophisticated investors or elderly clients on limited incomes who were risk-averse. Greenberg also failed to ensure that adequate supervisory procedures were developed or implemented relating to those determinations.
With regard to fees, the SEC's order notes that when one Agile hedge fund invested in another Agile hedge fund, investors were assessed performance and management fees on the leveraged portion of their investment. These fees, which totaled approximately $2 million between 2003 and 2006, were not disclosed to investors.
John Mulhern and Jay Scoggins of the SEC's Denver Regional Office conducted the SEC's investigation. The SEC's litigation will be led by Stephen McKenna. This investigation was based upon a referral from the Denver Regional Office examination staff.
# # #
For more information about this enforcement action, contact:
Donald M. Hoerl
Regional Director, SEC's Denver Regional Office
303-844-1060
Julie K. Lutz
Associate Regional Director, SEC's Denver Regional Office
303-844-1056
http://www.sec.gov/news/press/2010/2010-165.htm
SHORT SALES
AGENCY: Securities and Exchange Commission.
ACTION: Final rule; Interpretation.
SUMMARY: The Securities and Exchange Commission ("Commission") is adopting new Regulation SHO, under the Securities Exchange Act of 1934 ("Exchange Act"). Regulation SHO defines ownership of securities, specifies aggregation of long and short positions, and requires broker-dealers to mark sales in all equity securities "long," "short," or "short exempt." Regulation SHO also includes a temporary rule that establishes procedures for the Commission to suspend temporarily the operation of the current "tick" test and any short sale price test of any exchange or national securities association, for specified securities. Regulation SHO also requires short sellers in all equity securities to locate securities to borrow before selling, and also imposes additional delivery requirements on broker-dealers for securities in which a substantial number of failures to deliver have occurred. The Commission is also adopting amendments that remove the shelf offering exception, and issuing interpretive guidance addressing sham transactions designed to evade Regulation M.
The Commission is deferring consideration of the proposal to replace the current "tick" test with a new uniform bid test restricting short sales to a price above the consolidated best bid, and also deferring consideration of the proposed exceptions to the uniform bid test. The Commission will reconsider any further action on these proposals after the completion of the pilot established by Regulation SHO.
DATES: Effective Date: September 7, 2004, except Part 241 will be effective August 6, 2004, and §242.202T will be effective from September 7, 2004 to September 7, 2007.
Compliance Date: The compliance date for §§242.200 and 203 is January 3, 2005. The compliance date for §242.202T is the same as its effective date, September 7, 2004.
FOR FURTHER INFORMATION CONTACT: Any of the following attorneys in the Office of Trading Practices, Division of Market Regulation, Securities and Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-1001, at (202) 942-0772: James Brigagliano, Assistant Director, Lillian Hagen, Alexandra Albright, and Elizabeth Sandoe, Special Counsels, or Peter Chepucavage, Attorney Fellow.
SUPPLEMENTARY INFORMATION: The Commission is adopting Rules 200, 202T, and 203 of Regulation SHO1 and amending Rule 105 of Regulation M,2 and Rule 10a-13 under the Exchange Act.
Table of Contents
1. Introduction
2. Price Test — Proposed Rule 201
3. Rule 200 — Definitions and Marking Requirements
4. Rule 202T — Pilot Program
5. Rule 203 — Locate and Delivery Requirements for Short Sales
6. Rule 203(a) — Long Sales
7. Rule 105 of Regulation M — Short Sales in Connection with a Public Offering
8. Paperwork Reduction Act
9. Cost-Benefit Analysis
10. Consideration of Promotion of Efficiency, Competition, and Capital Formation
11. Final Regulatory Flexibility Analysis
12. Statutory Basis and Text of Adopted Amendments
I. Introduction
A short sale is the sale of a security that the seller does not own or any sale that is consummated by the delivery of a security borrowed by, or for the account of, the seller. In order to deliver the security to the purchaser, the short seller will borrow the security, typically from a broker-dealer or an institutional investor. The short seller later closes out the position by purchasing equivalent securities on the open market, or by using an equivalent security it already owned, and returning the security to the lender. In general, short selling is used to profit from an expected downward price movement, to provide liquidity in response to unanticipated demand, or to hedge the risk of a long position in the same security or in a related security.
On October 28, 2003, the Commission proposed Regulation SHO, which would replace Rules 3b-3, 10a-1, and 10a-2 under the Exchange Act.4 As proposed, Regulation SHO contained the following rules:
* Rule 200, which would replace Rule 3b-3 and: (1) define the term "short sale" to allow multi-service broker-dealers to aggregate their positions by separate trading units; and (2) define ownership of a security to address security futures products and unconditional contracts to purchase securities;
* Rule 201, which would replace Rule 10a-1 and apply a uniform price test for exchange-listed and Nasdaq NMS securities based upon the consolidated best bid instead of the current tick test based upon the last reported sale;
* Rule 202T, which would establish a procedure for the Commission to suspend on a temporary basis the operation of Rule 10a-1 and any short sale price test of any exchange or national securities association for specified securities; and
* Rule 203, which would replace current Rule 10a-2, incorporate provisions of the existing self-regulatory organization ("SRO") "locate" rules into a uniform Commission rule applicable to all equity securities, wherever they are traded, and impose additional delivery requirements on broker-dealers for securities in which a substantial amount of failures to deliver have occurred.
We also proposed revisions to Rule 105 of Regulation M (short selling in connection with a public offering) to eliminate the current shelf offering exception, and provide interpretive guidance addressing sham transactions designed to evade the rule.
We received letters from 462 commenters in response to proposed Regulation SHO.5 The responses varied widely, with some commenters arguing for more stringent short sale regulation and others advocating the elimination of many or all short sale restrictions.
After considering the comments received, and upon further examination of current market practices and the purposes underlying short sale regulation,6 we have decided to adopt certain provisions of proposed Regulation SHO and to defer consideration of other provisions. We are adopting proposed Rule 200, with some minor modifications. Rule 200, which incorporates Rule 3b-3, defines ownership for short sale purposes, and clarifies the requirement to determine a seller's net aggregate position. We have also decided to incorporate into Rule 200 the proposed requirements to mark sales in all equity securities "long," "short," or "short exempt."7 We believe that the ownership, aggregation, and marking requirements are important for all short sale regulations.
We are also adopting Rule 202T, which creates a procedure for the Commission to establish, through a separate order, a pilot program pursuant to which the Commission may exclude designated securities from the operation of the tick test of Rule 10a-1 and any short sale price test rule of any exchange or national securities association ("pilot"). Concurrently with this release, we are issuing an order establishing a pilot program employing the procedures of Rule 202T. 8 We have determined not to proceed with the uniform bid test of proposed Rule 201 until we have obtained the results of the pilot. Rule 10a-1, as well as all SRO price tests, will be maintained in present form for securities not included in the pilot.
We believe that conducting a pilot pursuant to Rule 202T is an important component of evaluating the overall effectiveness of price test restrictions on short sales. The pilot will allow us to obtain data on the impact of short selling in the absence of a price test to assist in determining, among other things, the extent to which a price test is necessary to further the objectives of short sale regulation, to study the effects of relatively unrestricted short selling on market volatility, price efficiency, and liquidity, and to obtain empirical data to help assess whether a short sale price test should be removed, in part or in whole, for some or all securities, or if retained, should be applied to additional securities.
The Commission's Office of Economic Analysis ("OEA") will gather and analyze data during the pilot period to assess trading behavior in the absence of short sale price restrictions. Additionally, researchers are encouraged to provide the Commission with their own empirical analyses of the pilot.9
We are adopting additional proposals in Regulation SHO, which we believe are necessary and appropriate regardless of whether short sales are subject to a price test, to clarify provisions and to address commenters' concerns. As adopted, Rule 203 creates a uniform Commission rule requiring broker-dealers, prior to effecting short sales in all equity securities, to "locate" securities available for borrowing, and imposes additional delivery requirements on broker-dealers for securities in which a substantial amount of failures to deliver have occurred ("threshold securities"). We believe that strong and uniform requirements in this area will reduce short selling abuses. The locate and delivery requirements will act as a restriction on so-called "naked" short selling.10
We are also adopting amendments to Rule 105 of Regulation M in order to eliminate the shelf exception. In the Proposing Release we sought comment on how to address "sham" transactions that are structured to give the false appearance that short sales are being covered with open market shares, when in fact, the short seller has arranged to cover the short sale with offering shares, thereby violating Rule 105. We are issuing interpretive guidance relating to "sham" transactions that violate Rule 105.
II. Price Test — Proposed Rule 201
We proposed Rule 201 of Regulation SHO to replace Rule 10a-1's tick test with a price test using the consolidated best bid as the reference point for permissible short sales. Specifically, subparagraph (b) of proposed Rule 201 would have required that all short sales in covered securities be effected at a price at least one cent above the consolidated best bid at the time of execution.11
The comments we received on the proposed price test varied widely. Some commenters (including the Investment Company Institute ("ICI"), North American Securities Administrators Association ("NASAA"), and many smaller investors) advocated more stringent short sale regulation. These commenters, favored extending the proposed bid test to smaller issuers and urged imposition of stricter locate and delivery requirements. Other commenters, despite supporting many of the initiatives, argued for maintaining the current "tick" test. The New York Stock Exchange ("NYSE"), a proponent of retaining the tick test, also contended that the NYSE should be allowed to maintain a tick test for short sales on the exchange even if the Commission determines to eliminate price restrictions on short sales.12 Additionally, the NYSE letter stated that it was representing the views of its issuers. None of these issuers submitted comments separately.13
A number of commenters, including some of the largest broker-dealers (e.g., J.P. Morgan, UBS Securities, Lehman Brothers), the Securities Industry Association ("SIA"), and one regional exchange, Chicago Stock Exchange ("CHX"), advocated that the Commission consider further the necessity of any price test (either the current tick test or the proposed bid test). Generally, these commenters supported the pilot as a good first step, but argued that the pilot should be shortened from the proposed two-year duration to one year to expedite this process. These commenters, and other broker-dealers (e.g., Goldman Sachs, Citigroup, Merrill Lynch, and Morgan Stanley), raised various concerns about the proposed price test, and opposed the Commission requiring market participants to expend time and resources to re-program systems for the proposed bid test prior to the completion of a pilot, especially if a possible outcome following the completion of the pilot is the removal of a price test altogether based on the results of the pilot.14
We have decided that the prudent course of action is to defer consideration of the proposed uniform bid test until after the conclusion of any pilot established pursuant to Rule 202T. As noted, the purpose of the pilot is to assist the Commission in considering alternatives, such as: (1) eliminating a Commission-mandated price test for an appropriate group of securities, which may be all securities; (2) adopting a uniform bid test, and any exceptions, with the possibility of extending a uniform bid test to securities for which there is currently no price test; or (3) leaving in place the current price tests.15
III. Rule 200 — Definitions and Marking Requirements
We are adopting Rule 200 to incorporate Rule 3b-3 of the Exchange Act,16 with some amendments to the rule's current text. One of the key changes in Rule 200 is the requirement to mark sell orders in all equity securities "long," "short," or "short exempt." Additionally, Rule 200 allows broker-dealers to calculate net positions in a particular security within defined trading units; incorporates the block-positioner exception from current Rule 10a-1(e)(13); and codifies prior interpretations related to the ownership of security futures products, and the unwinding of certain index arbitrage positions.17
A. Ownership
1. Unconditional Contracts to Purchase Securities — Rule 200(b)(2)
As proposed, paragraph (b) of Rule 200 would have amended the definition of unconditional contract to require the specification of a fixed price and amount of securities to be purchased in order for a person to claim ownership of the securities underlying the contract. Given our decision to maintain the status quo on the short sale price test in Rule 10a-1, we have determined not to amend the current definition of "unconditional contract" found in Rule 3b-3(b). Our decision primarily relates to our intent to preserve the operation of the current price test during the application of Rule 202T's pilot program. Amending qualifications for ownership of securities would affect net long positions, and thus have an impact on various trading strategies. However, we will continue to consider whether any future changes to the unconditional contract provision are appropriate, and may revisit our decision upon termination of any pilot that will be implemented pursuant to Rule 202T.
2. Ownership of Securities Underlying Securities Futures Products — Rule 200(b)(6)
We proposed Rule 200(b)(6) to achieve consistency with existing Commission guidance that defines when a person shall be deemed to own a security underlying a security futures contract.18 The proposed amendment provided that a person holding a long security futures position is not considered to own the underlying security, for Rule 200 purposes, until the security future stops trading and the future will be physically settled. In the Proposing Release, we stated that termination of trading is the moment at which an open position in a security future, either a long or short position, can no longer be closed or liquidated either by buying or selling an opposite position. At that point, the person obligated to deliver would be considered short, and a person entitled to acquire the securities would be considered long.19
One commenter addressed the Rule 200 proposal and asserted that a person who holds a security future, which obligates the person to take delivery of the underlying securities by physical settlement, should be considered long the securities.20 Additionally, the commenter argued that securities futures products are "materially different" from options, rights, warrants, and convertibles, which merely give the holder the right, but not the obligation, to acquire the securities.
We believe that the ownership language in Rule 3b-3 implicitly contemplates that there is a high degree of certainty that the person presently will obtain possession of the security. The distant time element of a futures product is inconsistent with this position. Moreover, the sale of securities related to a future-dated delivery contract necessitates borrowing for delivery, thus rendering the sale of the related securities a short sale. Therefore, a futures contract is more analogous to other derivative products than to an unconditional contract.
Therefore, we are adopting the proposed language relating to ownership of securities underlying a security futures contract. This interpretation is consistent with existing Commission guidance concerning the manner in which Rule 3b-3 addresses instances where a person owns a derivative instrument that entitles the person to acquire securities underlying the instrument, e.g., options, rights, warrants, convertibles, and security futures.21
3. Aggregation Units — Rule 200(f)
We are adopting aggregation unit netting in Rule 200(f). Historically, a multi-service broker-dealer was considered one entity, so all of its positions were aggregated to determine the firm's net position.22 However, firm-wide aggregation often interfered with the trading of independent units within the broker-dealer. The staff of the Division of Market Regulation therefore issued a no-action letter allowing multi-service broker-dealers to aggregate their positions within defined trading units.23 We proposed to incorporate trading unit aggregation, for purposes of determining the trading unit's net position, into Regulation SHO.24
As proposed and adopted, Rule 200(f) permits trading unit aggregation if a registered broker-dealer meets the following requirements: (1) the broker-dealer has a written plan of organization that identifies each aggregation unit, specifies its trading objective(s), and supports its independent identity;25 (2) each aggregation unit within the firm determines at the time of each sale its net position for every security that it trades; (3) all traders in an aggregation unit pursue only the trading objectives or strategy(ies) of that aggregation unit; and (4) individual traders are assigned to only one aggregation unit at any time.26
We believe that these conditions are necessary to prevent potential abuses associated with establishing aggregation units within multi-service broker-dealers. Specifically, we require a written plan of organization as a means to demonstrate that each unit is independent and engaged in separate trading strategies without regard to other trading units. Aggregation of the unit's net position prior to each sale limits the potential for abuse associated with coordination among units. The final two conditions, limiting traders to the pursuit of the trading strategies or objectives of the particular aggregation unit and the assignment to only one aggregation unit at a time, are both designed to maintain the independence of the units. Thus, if two or more traders or groups of traders (i.e., desks) within the same firm coordinate their trading activities, those traders or groups must be in the same aggregation unit.27
4. Block Positioners and Liquidation of Index Arbitrage Positions — Rule 200(d) and (e)
As proposed, we are incorporating the block positioner exception (currently found in subsection (e)(13) of Rule 10a-1) into Rule 200(d) because this provision directly relates to the calculation of a broker-dealer's net position. Block positioning occurs when a broker-dealer acts as principal in taking all or part of a block order placed by a customer in order to facilitate a transaction that might otherwise be difficult to effect in the ordinary course of trading.28 The block positioner may then seek to sell the securities so acquired. The exemption for block positioners addresses the interaction between the price test under Rule 10a-1 and the determination of the seller's net position under Rule 3b-3.29 A broker-dealer that engages in block-positioning will continue to be able to disregard economically neutral bona-fide arbitrage, risk arbitrage, and bona-fide hedge positions involving short stock components in determining its net position in the block-positioned security.
Under subparagraph (e) of Rule 200, we are adopting relief for sales effected in connection with the unwinding of an index arbitrage position. Rule 200(e) provides a limited relaxation of the requirement that a person selling a security aggregate all of the person's positions in that security to determine whether he or she has a net long position. In a manner similar to that permitted under the block positioner exception in Rule 200(d), this provision allows market participants to liquidate (or unwind) certain existing index arbitrage positions involving long baskets of stocks and short index futures or options without aggregating short stock positions in other proprietary accounts if and to the extent that those short stock positions are fully hedged. To qualify for the relief, the liquidation of the index arbitrage position must relate to a securities index that is the subject of a financial futures contract (or options on such futures) traded on a contract market, or a standardized options contract,30 notwithstanding that such person may not have a net long position in that security.31
Aggregation relief for index arbitrage positions was originally granted in a staff no-action letter.32 Proposed Rule 200(d) contained additional provisions that were not contained in the prior no-action letter. Three commenters supported the relief, but stated that the relief was too limited.33 Generally, these commenters preferred the relief as provided by the Merrill Lynch letter. We have carefully reviewed the comments and have determined to include the additional provisions in connection with the liquidation of an index arbitrage position. The Commission still believes that a market decline restriction is appropriate and in the public interest, and will avoid incremental selling pressure at the close of trading on a volatile trading day and at the opening of trading on the following day, since trading activity at these times may have a substantial effect on the market's short-term direction.
As proposed and adopted, the exception for unwinding index arbitrage positions provided in Rule 200(e) is limited to the following conditions: (1) the index arbitrage position involves a long basket of stock and one or more short index futures traded on a board of trade or one or more standardized options contracts; (2) such person's net short position is solely the result of one or more short positions created and maintained in the course of bona-fide arbitrage, risk arbitrage, or bona-fide hedge activities; and (3) the sale does not occur during a period commencing at the time that the Dow Jones Industrial Average ("DJIA") has declined below its closing value on the previous trading day by at least two percent and terminating upon the establishment of the closing value of the DJIA on the next succeeding trading day during which the DJIA has not declined by two percent or more from its closing value on the previous day. If a market decline triggers the application of subparagraph (e)(2), a broker-dealer must aggregate all of its other positions in that security to determine whether the seller has a net long position.34
B. Order-Marking Requirements — Rule 200(g)
We are adopting the new order-marking requirements proposed in Rule 201(c) and incorporating them into Rule 200(g). Since the new marking requirements apply to all equity securities, not just exchange-listed securities, we are removing them from current Rule 10a-1. The new order-marking requirements differentiate between "long," "short," and "short exempt" orders for all exchange-listed and over-the-counter equity securities.
Under the former marking requirements in Rule 10a-1(d), a broker-dealer could only mark an order to sell a security "long" if the security was carried in the account for which the sale is to be effected, or the broker-dealer is informed that the seller owns the security to be sold, and will deliver the security to the account for which the sale is effected as soon as possible without undue inconvenience or expense.35 We had proposed changing the marking requirement so that a sale could only be marked "long" if the seller owns the security being sold and either the security to be delivered is in the physical possession or control of the broker-dealer, or will be in the physical possession or control of the broker-dealer prior to settlement of the transaction.
As adopted, an order can be marked "long" when the seller owns the security being sold and the security either is in the physical possession or control of the broker-dealer, or it is reasonably expected that the security will be in the physical possession or control of the broker or dealer no later than settlement. We added the language "reasonably expected" because we acknowledge that it may be difficult for a person to know with certainty at the time of sale that a security will be in the possession or control of the broker-dealer prior to settlement. However, if a person owns the security sold and does not reasonably believe that the security will be in the possession or control of the broker-dealer prior to settlement, the sale should be marked "short." The sale could be marked "short exempt" if the seller is entitled to rely on an exception from the tick test of Rule 10a-1, or the price test of an exchange or national securities association.36 Short sales of pilot securities effected during any pilot period should be marked "short exempt."
The new marking requirements will eliminate the prior discrepancy between how Rule 3b-3 defined a short sale and the marking provisions previously found in Rule 10a-1. In addition, the new marking requirements should facilitate the surveillance and monitoring of compliance with Rule 10a-1. The change to the marking requirements will provide information that shows when exceptions from Rule 10a-1 are used.
IV. Rule 202T — Pilot Program
A. General
We proposed Rule 202T to provide a procedure for the Commission to suspend, on a pilot basis, the trading restrictions of the Commission's short sale price test, as well as any short sale price test of any exchange or national securities association, for short sales in such securities as the Commission designates by order as necessary or appropriate in the public interest and consistent with the protection of investors, after giving due consideration to the security's liquidity, volatility, market depth and trading market.37 We stated our belief that temporary suspension of Commission and SRO price tests is an essential component of evaluating the overall effectiveness of such restrictions, and would permit the collection of data on the impact of short selling in the absence of a price test.
Overall, thirty-eight commenters expressed support for a pilot program.38 Some commenters opposed any suspension of a price test for short sales, and expressed concern about possible pricing anomalies and disparate trading activity in securities within the same industry where one security is subject to a price test and another is not.39 We considered these suggestions together with other comments that not only supported the pilot, but recommended that the pilot criteria be expanded to include, among other things, less liquid securities; securities with position limit tiers for listed options; and stocks that currently qualify for the Regulation M exception for actively-traded securities.40
A number of commenters stated that the proposed two-year time span for the pilot would be too long.41 For, example, Nasdaq asserted that the pilot should only last as long as absolutely necessary, to minimize the impact on issuers and the market, and suggested a six-month or twelve-month pilot. The NYSE expressed concern that a two-year pilot is "an exceptionally long time," especially if there were no quick mechanism to shorten or end the pilot if it proves to dislocate market prices. The STA favored a six-month pilot.
After careful consideration of the comments received, we are adopting a modified version of proposed Rule 202T. As adopted, Rule 202T provides procedures for the Commission to suspend any short sale price test for such securities and for such time periods as the Commission deems necessary or appropriate, in the public interest and consistent with the protection of investors after giving due consideration to the securities' liquidity, volatility, market depth and trading market. Any such pilot would commence by separate order of the Commission, which would allow the Commission to act quickly should adverse findings result from any pilot. As part of that process, we would consider the concerns expressed by some commenters that any pilot last only as long as absolutely necessary to allow the Commission to gather sufficient data. The order establishing any such pilot would identify the pilot stocks and set forth the methodology we would use in selecting pilot and control group stocks. Any such order would also indicate the factors we plan to analyze in the pilot, such as the impact on market quality, price changes caused by short selling, costs imposed by the tick test, and the use of alternative means to establish short positions.
By separate order, the Commission is establishing a pilot that includes a subset of securities from a broad-based index. The order identifies the pilot stocks and sets forth the methodology we used in selecting pilot and control group stocks.42 We believe that a pilot established under Rule 202T using a subset of securities from a broad-based index will provide a balanced and targeted approach to assessing the efficacy of a price test for short sales. There is the potential that prices and trading activity may vary between securities included in a pilot and similar securities subject to the price test.43 However, to the extent there are price and trading activity variations, this is precisely the empirical data that the Commission seeks to obtain and analyze as part of our assessment as to whether the price test should be removed or modified, in part or whole, for actively-traded securities or other securities. 44
We appreciate the concerns expressed by some commenters that issuers subject to a pilot could be unfairly disadvantaged because of potentially abusive or manipulative behavior. We note, however, that most of the more liquid securities that will be appropriate for a pilot are traded on exchanges or other organized markets with high levels of transparency and surveillance. This would enhance the ability of the Commission and SROs to monitor trading behavior during the operation of any pilot and to surveil for manipulative short selling. Moreover, the general anti-fraud and anti-manipulation provisions of the federal securities laws will continue to apply to trading activity in these securities, thus prohibiting trading activity designed to improperly influence the price of a security.45 In addition, a pilot would suspend only the operation of the price test, while the other requirements of Regulation SHO, including the order-marking, locate and delivery requirements, would remain in effect.46
Further, as adopted, Rule 202T makes explicit that no SRO "shall have a rule that is not in conformity with or conflicts with" the suspension of a price test for the securities selected for the pilot. Although a few commenters asserted that SRO price tests should remain in effect even if the Commission determined to eliminate price restrictions on short sales,47 as we noted in the Proposing Release, we believe it would be inconsistent with, and detrimental to the goals of, Rule 202T and any pilot to allow SRO price tests to continue to apply to securities subject to the pilot. A pilot would be intended to allow the Commission to, among other things, study the effects of relatively unrestricted short selling on trading behavior for a select group of stocks. If pilot stocks remained subject to SRO price tests, the empirical data would be compromised and the value of the study undermined. As a result, Rule 202T, as adopted, prohibits the SROs from applying a price test for short sales in securities selected for a pilot during the operation of any pilot.
B. After-Hours Trading
We included in the Proposing Release our interpretation that the tick test applies to all trades in listed securities, whenever they occur, including in the after-hours market and after the consolidated transaction reporting system ceases to operate.48 A significant number of commenters objected to this position, arguing that there is limited liquidity after regular trading hours, and that the trades do not generate price effects associated with the abusive practices that the short sale rule is designed to prevent.49 These commenters further argued that many short sales that are executed after-hours are facilitating trades that are provisionally agreed to during regular trading hours, and accordingly provide liquidity to investors.50
Moreover, some commenters asserted that many after-hours trades are currently executed overseas due to the operation of Rule 10a-1.51 Excepting short sales executed after-hours on a pilot basis may result in these trades being executed in the United States, thus allowing for increased surveillance of these trades and providing increased liquidity to potential U.S. buyers.
In response to the comments received, Rule 202T, as adopted, establishes a procedure by which we may suspend on a pilot basis the tick test of Rule 10a-1(a) and any SRO short sale price test during such time periods as the Commission finds necessary or appropriate and consistent with the protection of investors. Any such pilot would commence by order of the Commission.52 The order described above establishes a pilot removing any price test for short sales of certain securities effected during certain after-hours periods.
V. Rule 203 — Locate and Delivery Requirements for Short Sales
A. "Locate" Requirement
We are adopting proposed Rule 203, with some modifications, after considering the comments received.53 As adopted, Rule 203(b) creates a uniform Commission rule requiring a broker-dealer, prior to effecting a short sale in any equity security, to "locate" securities available for borrowing. For covered securities, Rule 203 supplants current overlapping SRO rules. Specifically, the rule prohibits a broker-dealer from accepting a short sale order in any equity security from another person, or effecting a short sale order for the broker-dealer's own account unless the broker-dealer has (1) borrowed the security, or entered into an arrangement to borrow the security, or (2) has reasonable grounds to believe that the security can be borrowed so that it can be delivered on the date delivery is due.54 The locate must be made and documented prior to effecting a short sale, regardless of whether the seller's short position may be closed out by purchasing securities the same day.55 The rule provides for some limited exceptions, including for short sales effected in connection with bona-fide market making, as discussed in further detail below.
As proposed, Rule 203(b) would have allowed the "person for whose account the short sale is executed" to perform a locate.56 We agree with commenters that the locate requirement should apply to a regulated entity -- the broker-dealer effecting the sale -- and have modified the adopted rule accordingly.57 Therefore, the rule as adopted makes clear that the broker-dealer effecting the short sale has the responsibility to perform the locate.58
We requested comment in the Proposing Release on the manner in which persons could satisfy the "reasonable grounds" determination in the proposed rule. In particular, we asked whether blanket assurances that stock is available for borrowing, i.e., "Easy to Borrow" or "Hard to Borrow" lists, provide an accurate assessment of the current lending market in a manner that would not impede liquidity and the ability of market participants to establish short positions, while at the same time guarding against potential problems inherent with large extended settlement failures. 59 After considering the comments received, we believe that, absent countervailing factors, "Easy to Borrow" lists may provide "reasonable grounds" for a broker-dealer to believe that the security sold short is available for borrowing without directly contacting the source of the borrowed securities.60 In order for it to be reasonable that a broker-dealer rely on such lists, the information used to generate the "Easy to Borrow" list must be less than 24 hours old, and securities on the list must be readily available such that it would be unlikely that a failure to deliver would occur.61 Therefore, absent adequately documented mitigating circumstances, repeated failures to deliver in securities included on an "Easy to Borrow" list would indicate that the broker-dealer's reliance on such a list did not satisfy the "reasonable grounds" standard of Rule 203.62
Broker-dealers create "Hard to Borrow" lists to identify securities that are in limited supply. Thus, locates for securities on "Hard to Borrow" lists are likely to be difficult. However, the fact that a particular lender placed certain securities on a "Hard to Borrow" list cannot be taken to mean that the lender represents that securities that are not on the "Hard to Borrow" list are easy to borrow. Commenters viewed "Hard to Borrow" lists with circumspection,63 and we understand that such lists are not widely used by broker-dealers. Therefore, the fact that a security is not on a hard to borrow list cannot satisfy the "reasonable grounds" test of Rule 203(b)(1)(ii).
1. Exceptions from the Locate Requirement
a. Broker-Dealer Accepting Short Sale Order from Another Broker-Dealer — Rule 203(b)(2)(i)
Rule 203(b)(2)(i) provides a new exception from the uniform locate requirement of Rule 203(b)(1) for a registered broker or dealer that receives a short sale order from another registered broker or dealer that is required to comply with 203(b)(1). For example, where an introducing broker-dealer submits a short sale order for execution, either on a principal or agency basis, to another broker-dealer,64 the introducing broker-dealer has the responsibility of complying with the locate requirement. The broker-dealer that received the order from the introducing broker-dealer would not be required to perform the locate. However, a broker or dealer would be required to perform a locate where it contractually undertook to do so or the short sale order came from a person that is not a registered broker-dealer.65
b. Bona-fide Market Making
We are adopting the proposed exception from the uniform "locate" requirement, as Rule 203(b)(2)(iii), for short sales executed by market makers, as defined in Section 3(a)(38) of the Exchange Act,66 including specialists and options market makers, but only in connection with bona-fide market making activities.67 Bona-fide market making does not include activity that is related to speculative selling strategies or investment purposes of the broker-dealer and is disproportionate to the usual market making patterns or practices of the broker-dealer in that security. In addition, where a market maker posts continually at or near the best offer, but does not also post at or near the best bid, the market maker's activities would not generally qualify as bona-fide market making for purposes of the exception.68 Further, bona-fide market making does not include transactions whereby a market maker enters into an arrangement with another broker-dealer or customer in an attempt to use the market maker's exception for the purpose of avoiding compliance with Rule 203(b)(1) by the other broker-dealer or customer.69
c. Additional Exception from the Locate Requirement — Rule 203(b)(2)(ii)
Pursuant to the suggestions of other commenters, we are including an additional exception from the uniform locate requirement of Rule 203(b)(1) for situations where a broker-dealer effects a sale on behalf of a customer that is deemed to own the security pursuant to Rule 200, although, through no fault of the customer or the broker-dealer, it is not reasonably expected that the security will be in the physical possession or control of the broker-dealer by settlement date, and is thus a "short" sale under the marking requirements of Rule 200(g) as adopted.70 Such circumstances could include the situation where a convertible security, option, or warrant has been tendered for conversion or exchange, but the underlying security is not reasonably expected to be received by settlement date.71 Rule 203(b)(2)(ii) as adopted provides that in all situations, delivery should be made on the sale as soon as all restrictions on delivery have been removed, and in any event no later than 35 days after trade date, at which time the broker-dealer that sold on behalf of the person must either borrow securities or close out the open position by purchasing securities of like kind and quantity.72
Two commenters advocated maintaining the current exception from the "affirmative determination" requirements of NASD Rule 3370 for short sales that result in fully hedged or arbitraged positions.73 One comment letter requested an exception from the proposed locate and delivery requirements of Rule 203 in a situation where a market participant has a long position in warrants or rights which are exercisable within 90 days and are subject to a fixed price per share conversion ratio.74 The other comment letter requested an exception from the proposed locate and delivery requirements in the situation where a market participant is long in-the-money call options.75 The commenter argued that excepting short sales in such situations promotes the ability of smaller issuers to acquire financing.
We have decided not to incorporate an exception from the locate and delivery requirements of Rule 203 for short sales that result in bona-fide fully hedged or arbitraged positions. Because "bona-fide" hedging and arbitrage can be difficult to ascertain, we are concerned about including a blanket exception for some activity that may have the potential to harm issuers and shareholders.76 During the period of the pilot, we prefer instead to address the situations noted by the commenters, and other similarly situated entities, through the exemptive process, to the extent warranted.77 This will allow us to consider the particular facts and circumstances relevant to each request, as well as any potentially negative ramifications, and, should we gain comfort with the described transaction(s), fashion appropriate relief.
Additionally, we have declined at this time to include an express exception from the locate requirements of Rule 203(b)(1) for transactions in exchange traded funds ("ETFs").78 We have observed high levels of fails in some ETFs. Rather than providing a blanket exception from the requirements of Rule 203, we would prefer instead to address the treatment of ETFs through the exemptive process, which would be consistent with the prior treatment of ETFs.79 In considering any exemptive request, the Commission would evaluate the causes of large fails in certain ETFs, as well as potential remedies to resolve such fails, if necessary.
B. Short Sales in Threshold Securities — Rule 203(b)(3)
1. Threshold Securities
The Commission has decided to adopt, with certain modifications from what was proposed, additional requirements targeted at stocks that have a substantial amount of failures to deliver. As adopted, Rule 203(b)(3) requires any participant of a registered clearing agency ("participant")80 to take action on all failures to deliver that exist in such securities ten days after the normal settlement date, i.e., 13 consecutive settlement days.81 Specifically, the participant is required to close out the fail to deliver position by purchasing securities of like kind and quantity.
With slight modification from the proposal, a "threshold security" is defined in Rule 203(c)(6) as any equity security of an issuer that is registered under Section 12, or that is required to file reports pursuant to Section 15(d) of the Exchange Act82 where, for five consecutive settlement days: there are aggregate fails to deliver at a registered clearing agency of 10,000 shares or more per security; that the level of fails is equal to at least one-half of one percent of the issuer's total shares outstanding; and the security is included on a list published by an SRO. 83 We believe this threshold characterizes situations where the ratio of unfulfilled delivery obligations at the clearing agency at which trades are settled represents a significant number of shares relative to the company's total shares outstanding. We believe that such circumstances warrant action designed to address potential negative effects.84 This narrowly targeted threshold will not burden the vast majority of securities where there are not similar concerns regarding settlement.85 Our OEA analyzed recent data from NSCC on fails to deliver and calculated that approximately 3.9% of all exchange-listed and Nasdaq securities, and 4.0% of all securities, would meet this threshold.86
In order to be deemed a threshold security, and thus subject to the restrictions of Rule 203(b)(3), a security must exceed the specified fail level for a period of five consecutive settlement days. Similarly, in order to be removed from the list of threshold securities, a security must not exceed the specified level of fails for a period of five consecutive settlement days.87 This five-day requirement will address the potential situation where a security exceeds the fails level on one day, based on an aberrant fail to deliver that may not be indicative of the usual pattern of that particular security, and thus would prevent potential "flickering" of securities in and out of the list of threshold securities.88 Rule 203(b)(3) is intended to address potential abuses that may occur with large, extended fails to deliver.89 We believe that the five-day requirement will facilitate the identification of securities with extended fails.
As is currently the practice for Nasdaq securities that exceed the threshold designated in NASD Rule 11830, the pertinent SRO will be responsible for publishing a daily list of the threshold securities that are listed on their markets, or for which the SRO bears the primary surveillance responsibility.90 The SROs derive the information necessary to calculate the list of threshold securities from data on fails to deliver currently received from NSCC.91
2. Close-out Requirement
As proposed, the rule would have specified that, for short sales of any security meeting this threshold, the selling broker-dealer must deliver the security no later than two days after the settlement date. If for any reason such security were not delivered within two days after the settlement date, the rule would have restricted the broker-dealer, including market makers, from executing additional short sales for the next 90 days in such security for the person for whose account the failure to deliver occurred, unless the broker-dealer or the person for whose account the short sale is executed, borrowed the security or entered into a bona-fide arrangement to borrow the security, prior to executing the short sale. In addition, the rule would have required the registered clearing agency that processed the transaction to refer the party failing to deliver to the NASD and the designated examining authority for such broker-dealer for appropriate action; and to withhold a benefit of any mark-to-market amounts or payments that otherwise would be made to the party failing to deliver.
Some commenters argued that under the confines of current settlement practices and procedures, it is not practical to assign delivery failures to a particular clearing firm customer account. It was noted that because NSCC's continuous net settlement ("CNS") system nets all buys and sells in each security for each NSCC participant, broker-dealers cannot determine which customer's transaction or account gave rise to a failure to deliver.92 We note that while this may be the current situation in the industry, if the Commission believes that the rules as adopted are not having the intended effects of reducing potentially manipulative behavior, we may consider additional rulemaking that could require broker-dealers to identify individual accounts that are causing fails to deliver.
We have considered the comments received, and have adopted a rule that differs in the mechanics from the proposed rule, but continues to preserve the goal of limiting failures to deliver in threshold securities. As adopted, Rule 203(b)(3) requires action if a fail in a threshold security remains open ten days after the settlement date, i.e., for thirteen consecutive settlement days.93 Specifically, Rule 203(b)(3) requires a participant of a clearing agency registered with the Commission94 to take action to close out the fail to deliver that has remained for thirteen consecutive settlement days by purchasing securities of like kind and quantity.95 In addition, Rule 203(b)(3)(iii) states that the participant, and any broker-dealer for which it clears transactions, including any market maker that would otherwise be entitled to rely on the bona-fide market making exception, is prohibited from effecting further short sales in the particular threshold security without borrowing, or entering into a bona-fide arrangement to borrow, the security until the fail to deliver position is closed out. To the extent that the participant can identify the broker-dealer(s) or account(s) that have contributed to the fail to deliver position, the requirement to borrow or arrange to borrow prior to effecting further short sales should apply to only those particular broker-dealer(s) or account(s). Rule 203(b)(3)(v) states that where a participant enters into an arrangement with a counterparty to purchase securities as required by Rule 203(b)(3), and the broker or dealer knows or has reason to know that the counterparty will not deliver the securities, the broker or dealer will not have fulfilled the requirements of the rule.96
The requirement to close out fail to deliver positions in threshold securities that remain for thirteen consecutive settlement days does not apply to any positions that were established prior to the security becoming a threshold security.97 However, if a participant's fail to deliver position is subsequently reduced below the pre-existing position, then the fail to deliver position excepted by this subparagraph shall be the lesser amount.98 Rule 203(b)(3)(iv) also provides that a participant may reasonably allocate its responsibility to close out open fail positions in threshold securities to another broker-dealer for which the participant is responsible for settlement. Thus, participants that are able to identify the accounts of broker-dealers for which they clear may allocate the responsibility to close out open fail to deliver positions to the particular account(s) whose trading activities have caused the fail to deliver position. Absent such identification, however, the participant would remain subject to the close out requirement.
3. Other Proposed Requirements
We are not adopting the additional requirements of proposed Rule 203(b)(3)(ii), which would have required a registered clearing agency that processed the transaction to refer the party failing to deliver to the NASD and the designated examining authority for such broker-dealer for appropriate action; and withhold a benefit of any mark-to-market amounts or payments that otherwise would be made to the party failing to deliver. Since the Proposing Release was issued, Commission staff and the SROs have developed new procedures to identify and inquire regarding failures to deliver that achieve the goals of the proposed notification requirement. This includes the daily dissemination by NSCC to the Commission and the SROs of a report listing information on all participant short obligations for all equity securities with aggregate clearing short positions greater than 10,000 shares, which is being used by the SROs to initiate inquiries with members concerning the cause of the fails and whether there was compliance with regulatory requirements.
In addition, NSCC and other commenters noted that, due to the manner in which the CNS system currently calculates each participant net position in a security, it is not possible to distinguish between obligations to deliver that are the result of short sales as opposed to long sales.99 As such, it is not possible to determine whether a mark paid to a participant is a "benefit" received in connection with a fail to deliver position resulting from a short sale.
We are not adopting at this time the proposal that would require NSCC to withhold mark-to-market amounts paid to individuals. However, the Commission intends to pay close attention to the operation and efficacy of the provisions we are adopting in Rule 203, and will consider whether any further action is warranted.
4. Market Makers
We received a number of comments from market makers, including options market makers, on the proposal not to provide an exception for market makers from the special delivery requirements applicable to securities that meet the designated threshold.100 Some of these commenters stated that the effect of not including such an exception would be to cease altogether options trading in securities that are difficult to borrow, as it was argued that no options market maker would make markets without the ability to hedge by selling short the underlying security.101 In addition, another commenter stated that the heightened delivery requirements for threshold securities could drain liquidity in other securities where there is no current indication of significant settlement failures.102 The commenter believed that, while a blanket exception from the heightened delivery requirements would be preferable, at a minimum the implementation of any such provision should not apply to market maker positions acquired prior to the effective date of the rule, and likewise should not apply to any short position acquired prior to the time that the subject security meets the designated threshold.
We note that the close out requirements of Rule 203(b)(3) will only apply to fail to deliver positions in threshold securities, and will not apply to any fail to deliver positions established prior to the security meeting the threshold.103 As such, we believe that this addresses in part the commenters' concerns that market makers would need to assess the probability of a security meeting the threshold at some point in the future. Moreover, we expect that a small percentage of securities for which there are associated options will exceed the threshold.104 In light of this, we believe that the effects of not including a market maker exception from the heightened delivery requirement will not be as severe as some of the commenters have described. Moreover, while some of these commenters have opined that options market makers are not responsible for significant failures to deliver,105 other commenters and academics have questioned this assertion.106
Therefore, while market makers (including options market makers) engaged in bona-fide market making will continue to be excepted from the locate requirement of Rule 203(b)(1), even when effecting short sales in threshold securities, we have decided at this time not to extend an exception to market makers from the requirements to close out fails to deliver in such securities that remain for thirteen consecutive settlement days. Moreover, as discussed previously, Rule 203(b)(3)(iii) provides that until the market maker, or the participant that clears for the market maker, takes action to close out any such fails to deliver that remain ten days after the normal settlement date, the market maker shall be unable to rely on the exception in Rule 203(b)(2)(iii) from the requirement to "borrow or arrange to borrow" for further short sales in such security.
We have, however, included a limited exception from the close out requirement to allow registered options market makers to sell short threshold securities in order to hedge options positions, or to adjust such hedges, if the options positions were created prior to the time that the underlying security became a threshold security. Any fails to deliver from short sales that are not effected to hedge pre-existing options positions, and that remain for thirteen consecutive settlement days, are subject to the mandatory close out requirement. We will, however, take into consideration information that shows that this provision operates significantly differently from our expectations.
VI. Rule 203(a) — Long Sales
We are adopting subparagraph (a) of Rule 203, which covers delivery requirements applicable to long sales of securities, largely as proposed. Rule 203(a) incorporates current Rule 10a-2.
As proposed, Rule 203(a) would have provided that if a broker-dealer knows or should know that a sale was marked long, the broker-dealer must make delivery when due and cannot use borrowed securities to do so. The proposed rule would have provided that the delivery requirements would not apply in three situations: to the loan of a security through the medium of a loan to another broker or dealer; where the broker or dealer knows or has been reasonably informed by the seller that the seller owns the security and will deliver it to the broker or dealer prior to the scheduled settlement of the transaction; or where an exchange or securities association finds, prior to the loan or fail, that the sale resulted from a good-faith mistake, the broker-dealer exercised due diligence, and either that requiring a buy-in would result in undue hardship or that the sale had been effected at a permissible price. The proposed requirements would have extended to all securities, not just to those registered on an exchange.
Three commenters supported the proposed changes, believing that they would ensure greater consistency across markets and securities.107 One commenter requested that the rule except long sales that fail, through no fault of the seller, because of processing delays.108 In addition, two commenters suggested that the proposed Rule did not adequately address long sale delivery fails.109
After considering comments received, we are adopting the changes proposed, with one modification. Pursuant to proposed Rule 203(a), one of the circumstances in which a fail or delivery of borrowed shares would have been permitted was where, prior to the sale, the broker or dealer knew that the seller owned the securities and the seller had represented that he or she would deliver them to the broker in time for settlement. Although we believe it was implicit in the proposed rule text (and in current Rule 10a-2), we are including in the rule text the predicate that the seller fails to make such delivery after advising the broker-dealer that he or she would deliver the securities in time for settlement.110
As adopted, Rule 203(a) requires that if a broker-dealer knows or should know that a sale of an equity security is marked long, the broker-dealer must make delivery when due and cannot use borrowed securities to do so. This delivery obligation does not apply in three circumstances: (1) the loan of a security through the medium of a loan to another broker or dealer; (2) where the broker or dealer knows or has been reasonably informed by the seller that the seller owns the security and will deliver it to the broker or dealer prior to the scheduled settlement of the transaction and the seller fails to make such delivery;111 or (3) where an exchange or securities association finds, prior to the loan or arrangement to loan any security for delivery, or failure to deliver, that the sale resulted from a good-faith mistake, the broker-dealer exercised due diligence, and either that requiring a buy-in would result in undue hardship or that the sale had been effected at a permissible price.112
The new rule is consistent with the Commission's view that delivery requirements are important for all securities, particularly those with a lower market capitalization that may be more susceptible to abuse. Moreover, Rule 203(a) provides that on a long sale, a broker-dealer cannot fail or loan shares unless, in advance of the sale, it ascertained that the customer owned the shares, and had been reasonably informed that the seller would deliver the security prior to settlement of the transaction. This requirement is consistent with changes being made to the order marking requirements, which require that for an order to be marked long, the seller must own the security.113
VII. Rule 105 of Regulation M — Short Sales in Connection with a Public Offering
A. Generally
Rule 105 of Regulation M prohibits a short seller from covering short sales with offering securities purchased from an underwriter or broker or dealer participating in the offering, if the short sale occurred during the Rule's restricted period, typically the five-day period prior to pricing.114 The reason for the prohibition is that pre-pricing short sales that are covered with offering shares artificially distort the market price for the security, preventing the market from functioning as an independent pricing mechanism and eroding the integrity of the offering price.115 Prices of "follow-on offerings"116 are typically based on a stock's closing price prior to the time of pricing, and thus short sales during the period immediately preceding pricing that reduce the market price can result in a lower offering price. The goal of Rule 105 is to promote offering prices that are based upon open market prices determined by supply and demand rather than artificial forces.
Rule 105 does not prohibit pre-pricing short sales, in recognition of the fact that if such sales are motivated by a short seller's evaluation of the stock's future performance, they can contribute to pricing efficiency and the creation of a correct market price. Rule 105 does, however, prohibit using offering shares to cover any such pre-pricing short sales. A trader who sells short pre-pricing and knows or has a high degree of assurance that he will be able to obtain covering shares in the offering does not assume the same market risk as a short seller who intends to cover using open market shares, and may not be contributing to pricing efficiency and true price discovery. Therefore, the rule prohibits pre-pricing short sales, effected within five days of pricing of an offering, from being covered with offering securities acquired from an underwriter or other broker-dealer participating in the offering. Moreover, this manipulative conduct can negatively affect the issuer, which receives reduced offering proceeds as a result of the lower offering price, and harms the market by inhibiting the capital raising process. In addition, the presence of such shorting activity can lead other investors, who believe that the short selling is the result of an evaluation of the stock's value, to sell short as well. By prohibiting such artificial selling activity, the Rule contributes to the integrity of the capital raising process.
B. Shelf Offerings
In the Proposing Release, we proposed to amend Rule 105 to eliminate the shelf offering exception.117 We are adopting the amendment as proposed.
When the Commission initially adopted the shelf exception in Rule 105, it stated that it might be necessary for the Commission to reevaluate the exception in the event such offerings became more common.118 One of the reasons for the adoption of the shelf offering exception was the generally accepted view that shelf offerings were not as susceptible to manipulation as non-shelf offerings.119 At the time Regulation M was adopted, it was our understanding that potential investors generally were not aware of a takedown from a shelf registration until immediately prior to its occurrence, and thus pre-pricing short sales were arguably not focused on the prospective offering. Today, however, shelf offerings can have many characteristics of non-shelf offerings. They are likely to utilize the same marketing efforts -- road shows and other special selling efforts -- that are used with non-shelf offerings, and thus investors often have notice of a shelf offering before it occurs. Moreover, since the initial adoption of Rule 105, equity shelf offerings have become commonplace.
We believe that using offering shares to cover short sales effected prior to pricing of a shelf offering has the same negative effect as in non-shelf offerings. In light of the increased use of shelf offerings, we believe that the shelf exception presents an increased potential for the type of manipulative conduct that Regulation M is designed to prevent.
We received three comment letters on Rule 105. 120 One commenter argued that the exception should be retained because allowing offerees to act on their conviction that the proposed offering is overpriced by shorting in advance of pricing, leads to the creation of a "true" market price. 121 As noted above, Rule 105 does not prevent short sellers from contributing to pricing efficiency by short selling in advance of an offering. Another commenter urged the Commission to retain the exception for shelf offerings that occur on an "overnight" or "bought deal basis" where no red herring or preliminary prospectus is distributed.122 The Commission believes that even though no preliminary prospectus is issued in these takedowns, manipulative pre-pricing short sales could take place if other marketing efforts prior to the offering put investors on notice of the offering. We therefore believe that granting a blanket exception for these offerings is not appropriate.
By providing that shelf offering prices will be based upon market prices that are not artificially influenced, the amendment will benefit both issuers and investors. It will promote the integrity of the capital raising process, enhance investor confidence in our markets, and help protect issuers conducting shelf offerings from receiving reduced offering proceeds as a result of manipulative conduct. 123
C. Sham Transactions
In the Proposing Release, the Commission noted its concern with sham transactions that are structured to appear to comply with Rule 105, but which in fact violate the Rule. Such transactions are undertaken to give the appearance that pre-pricing short sales are not covered with offering shares, but instead are covered with shares purchased in the open market. We sought comment on how to address these transactions. We did not receive any comments on this issue. We have decided to issue interpretive guidance to address transactions that violate Rule 105 by utilizing offering shares to cover short sales made in the pre-pricing restricted period, while structuring the transactions so as to falsely give the appearance that the short sale has been covered using shares purchased in the open market. Transactions structured in this way violate Rule 105. Some examples of sham transactions that would violate Rule 105 follow. These examples are illustrative, and are not meant to be exhaustive.
1. Arrangements to Purchase
In the first example of a sham transaction, short sales are effected during the pre-pricing restricted period and are covered using offering securities obtained through an arrangement with a third party who acquires the securities in the primary offering.124 In this transaction, the trader is attempting to accomplish indirectly what he or she cannot do directly, i.e., a type of short sale transaction prohibited by Rule 105.125
2. Sell/Buy and Buy/Sell
In the second example of a sham transaction, a trader effects pre-pricing short sales during the Rule 105 restricted period, receives offering shares, sells the offering shares into the open market, and then contemporaneously or nearly contemporaneously purchases an equivalent number of the same class of shares as the offering shares, which are then used to cover the short sales. Where the transaction is structured such that there is no legitimate economic purpose or substance to the contemporaneous purchase and sale, no genuine change in beneficial ownership,126 and/or little or no market risk, that transaction may be a sham transaction that violates Rule 105.
We do not believe it necessary or desirable to add rule language to address these kinds of trading, as this activity violates the current rule and can vary in its details. The Commission will continue to enforce Rule 105 in the face of sham transactions designed to evade the Rule. In addition, if such sham transactions are used as part of a fraudulent or manipulative scheme, the conduct may also violate the Commission's anti-fraud and anti-manipulation provisions, including but not limited to, Sections 9(a) and 10(b) of the Exchange Act.127
VIII. Paperwork Reduction Act
The adopted amendments to Regulation SHO contain collection of information requirements within the meaning of the Paperwork Reduction Act of 1995.128 We published a notice requesting comment on the collection of information requirements in the Proposing Release, and submitted these requirements to the Office of Management and Budget ("OMB") for review in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. OMB has approved these requests. We did not receive comments on the proposed collection of information requirements.
Compliance with the adopted amendments to Regulation SHO and Rule 105 of Regulation M will be mandatory. The Commission will not keep the information required by the amendments confidential. An agency may not conduct or sponsor, and a person is not required to respond to, an information collection unless it displays a currently valid OMB control number. The title of the affected collection is "Regulation SHO" under OMB control number 3235-0589.
A. Summary of Collections of Information
Rule 200(g) contains a requirement that all sell orders in equity securities be marked "long," "short," and "short exempt." Currently, Rule 10a-1(c) prohibits the execution of a sell order for a security covered by Rule 10a-1 unless the order is marked either "long" or "short." Regulation SHO contains a new collection of information because the collection would cover a much larger number of securities. Rule 200(g) of Regulation SHO adds two elements to the existing marking requirement. First, a new category for "short exempt" orders is being added. Second, the marking requirement is being extended to apply to all equity securities, including exchange-listed securities, Nasdaq NMS, Nasdaq SmallCap, OTCBB, and Pink Sheet securities. By adopting Rule 200(g) of Regulation SHO, Rule 10a-1(c) is being repealed and any collection of information under Rule 10a-1 is being eliminated.
Sell orders of exchange-listed and Nasdaq securities are already marked "long," "short," or "short exempt" pursuant to Rule 10a-1, NYSE Rule 440B.20, and the ITS Plan. Nasdaq NMS and Nasdaq SmallCap securities are also currently subject to a marking requirement pursuant to NASD Rule 4991. Rule 200(g) of Regulation SHO simply codifies current industry practice for exchange-listed and Nasdaq securities into a uniform marking requirement
Rule 203(b)(1) contains a requirement that broker-dealer must locate securities available for borrowing prior to effecting a short sale transaction. Subparagraph (iii) of Rule 203(b)(1) requires documentation of compliance with Rule 203(b)'s locate requirement. We note, however, that current SRO rules already require a written record documenting compliance with their locate rules.129
B. Use of Information
The information required by Regulation SHO is necessary for the execution of the Commission's mandate under the Exchange Act to prevent fraudulent, manipulative and deceptive acts and practices by broker-dealers. The purpose of the information collected is to enable the Commission, a national securities exchange or national securities association to monitor whether a person effecting a short sale covered by proposed Regulation SHO is acting in accordance with Regulation SHO. In particular, requiring each order to be marked either "long," "short," or "short exempt" would aid in ensuring compliance with Rule 203 and current Rule 10a-1. Moreover, the "short exempt" category will aid in surveillance for compliance with the exceptions from these rules.
C. Respondents
The marking provision in Rule 200(g) will apply to all 6,553 active brokers or dealers that are registered with the Commission. The Commission has considered each of these respondents for the purposes of calculating the reporting burden under proposed Regulation SHO.
D. Total Annual Reporting and Recordkeeping Burdens
Rule 200(g) of Regulation SHO requires all brokers or dealers to mark all sell orders appropriately as "long," "short," or "short exempt" for all equity securities. We estimate that all of the approximately 6,553 active registered broker-dealers130 effect sell orders in securities covered by proposed Regulation SHO. For purposes of the Paperwork Reduction Act, the Commission staff has estimated that a total of 1,465,563,860 trades are executed annually.131
Currently, under both Commission and SRO rules, broker-dealers are obligated to document certain order information. Rule 10a-1 requires sell orders of exchange-listed and Nasdaq securities to be marked "long," "short," or "short exempt." NYSE Rule 440B.20, the ITS Plan, and NASD Rule 4991132 additionally impose a marking requirement. Rule 200(g) of Regulation SHO simply codifies the current practice for exchange-listed and Nasdaq securities into a uniform marking requirement.
Based on the number of annual trades and number of active registered broker-dealers, the average annual responses by each respondent is approximately 223,647. Each response of marking orders "long," "short," or "short exempt" takes approximately .000139 hours (.5 seconds) to complete.133 Thus, the total estimated annual hour burden per year is 203,713 burden hours (1,465,563,860 responses @ 0.000139 hours/response). A reasonable estimate for the paperwork compliance for the proposed rules for each broker-dealer is approximately 31 burden hours (223,647 responses @ .000139 hours/response) or a total of 203,713 burden hours / 6,553 respondents.
IX. Cost-Benefit Analysis
We are sensitive to the costs and benefits of our rules and we have considered the costs and benefits of our adopted rules. To assist us in evaluating the costs and benefits, in the Proposing Release, we encouraged commenters to discuss any costs or benefits that the rules might impose. In particular, we requested comment on the potential costs for any modification to both computer systems and surveillance mechanisms and for information gathering, management, and recordkeeping systems or procedures, as well as any potential benefits resulting from the proposals for registrants, issuers, investors, brokers or dealers, other securities industry professionals, regulators, and others. Commenters were requested to provide analysis and data to support their views on the costs and benefits associated with proposed Regulation SHO and proposed amendments to Rule 105 of Regulation M. We received very few comments providing cost or benefit estimates.
A. Costs and Benefits of the Adopted Amendments in Regulation SHO
We believe that Regulation SHO simplifies and updates short sale regulation in light of numerous market developments since short sale regulation was first adopted in 1938. First, Rule 200 incorporates current Rule 3b-3 to provide ownership definitions for short sale purposes, clarifies the requirement to determine a seller's net aggregate position, and requires sales in all equity securities to be marked "long," "short," or "short exempt." Second, Rule 202T establishes procedures for the Commission to exclude designated securities from the operation of the tick test of Rule 10a-1 and any short sale price test rule of any exchange or national securities association. Third, Rule 203 incorporates current provisions applicable to long sales under current Ruler 10a-2. Rule 203 additionally creates a uniform Commission rule requiring broker-dealers to "locate" securities available for borrowing prior to effecting short sales in all equity securities, and imposes additional requirements on securities that have a substantial amount of failures to deliver. Finally, the amendments to Rule 105 of Regulation M eliminate the current shelf offering exception, such that short sales may not be covered with offering securities purchased from an underwriter or other broker-dealer participating in the shelf offering.
1. Rule 200: Definitions
a. Ownership of Securities Underlying Securities Futures Products
i. Benefits
The codification of existing Commission guidance regarding when a person is deemed to own a security underlying a securities futures contract provides important compliance benefits. The interpretation is designed to ensure consistency with the way current Rule 3b-3 addresses several instances where a person owns a security that entitles a person to acquire securities underlying the instrument, e.g., options, rights, warrants, and convertibles. Additionally, by codifying existing guidance, Regulation SHO clarifies and facilitates compliance with the short sale rule for persons trading in securities futures.
ii. Costs
We do not believe that codifying existing guidance will impose costs or result in lost business opportunities. Although the Commission did not receive comments quantifying the costs related to the codification, we note that the guidance is well established and has been adhered to by the industry.134
b. Aggregation Units
i. Benefits
Permitting aggregation unit netting provides enhanced flexibility and liquidity to both broker-dealers and the market as a whole. Subject to four expressed conditions, Rule 200(f) permits multi-service broker-dealers to calculate net positions in a particular security within defined trading units apart from the positions held by other aggregation units within the firm. This allows multi-service firms to pursue different trading strategies, within certain parameters, without being restricted by limitations associated with firm-wide aggregation. The greater trading flexibility, through use of aggregation unit netting, should improve the liquidity provided by these firms.
ii. Costs
We believe that there are no costs associated with aggregation unit netting since firms are not required to use aggregation units. Aggregation of net positions within defined trading units is entirely optional and will likely be used by firms that believe it is cost effective to do so. However, firms that choose to make use of aggregation unit netting must comply with requirements set forth in Rule 200(f).135 Compliance with aggregation unit netting requirements may impose fewer costs to broker-dealers than if the firms use alternative means, such as establishing separate broker-dealers for each trading desk's strategy to ensure the independence of each trading desk. Industry sources maintain that the costs associated with aggregation unit netting are nominal. Furthermore, the technology to facilitate aggregation unit netting is widely available.
c. Liquidation of Index Arbitrage Position
i. Benefits
Codifying the liquidation index arbitrage relief, in Rule 200(e), facilitates pricing efficiency while preserving the fundamental objectives of short sale price regulation. By focusing on the timing of the liquidation of all the index arbitrage positions, rather than on the timing of the establishment of individual index arbitrage positions,136 Rule 200(e) relieves firms from the compliance burdens of tracking different positions of fungible securities according to the timing or circumstances related to their acquisition. Additionally, it reduces the possibility of unintended effects that may penalize buy-side index arbitrage strategies involving the purchase of stocks during times of market stress.
Subparagraph (e)(3) of Rule 200 provides a 2% market decline restriction137 so that markets can avoid incremental selling pressure during volatile trading days. The safeguard benefits all market participants by limiting selling pressure at the close of trading on a volatile trading day and at the opening of trading on the following day, since trading activity at these times may have a substantial effect on the market's short-term direction. Lastly, inclusion of the 2% safeguard provides consistency within the equities markets. In 1999, the NYSE amended its rules on index arbitrage restrictions to include the 2% trigger.138 The Commission's adoption of the same trigger provides a uniform protective measure.
ii. Costs
If the unwinding of the index arbitrage position occurs during a period when the DJIA has declined by 2%, short sellers will not be permitted to use the price test exemption, and thus will incur additional costs.139 Therefore, Rule 200(e)(3) may increase costs for short sellers during certain times of market decline. We estimate that any costs incurred will be limited to compliance with Rule 10a-1's tick test. The safeguard simply limits the relief from the price test for short sales of securities held in an index arbitrage position. The Commission did not adopt a blanket prohibition of short sales during a market decline; rather, the effect of subparagraph (e)(2) is to require such sales to comply with the short sale price test.
d. Order Marking Requirement
i. Benefits
The new order marking requirements provide important benefits for investors and the market as a whole. First, because the new order-marking requirements extend beyond exchange-listed equity securities to include over-the-counter equity securities, i.e., OTCBB and Pink Sheet securities, they provide a uniform practice designed to ensure consistency within the equity markets. Second, the marking requirement will generate information identifying when and under what circumstances certain exceptions to the price test are used. Third, the new marking requirements benefit the surveillance of previously undetected violations of Rule 10a-1. Under the prior requirements, orders marked "long," despite having to borrow shares to consummate delivery, were handled and executed as long sales.
Furthermore, the requirement of physical possession or control, or the reasonable expectation that the security will be in the possession or control of the broker-dealer no later than settlement, in order to mark an order "long," benefits the clearance and settlement process. Clearance and settlement systems are designed to preserve financial integrity and minimize the likelihood of systematic disturbances by instituting risk-management systems. Requiring a broker-dealer to have possession or control of the securities before it can mark an order long assists in mitigating settlement and credit risks that can affect the stability and integrity of the financial system as a whole.
ii. Costs
The addition of the classification of "short exempt" to the marking requirements will impose certain nominal costs on broker-dealers. According to industry sources, some broker-dealers already use the short exempt classification when marking certain sell orders. Additionally, SRO rules already either require or advise members to utilize the "short exempt" designation on such sell orders. However, broker-dealers not already using the "short exempt" classification will incur a one-time cost associated with programming. Industry sources estimated that implementation costs would be approximately $100,000 to $125,000.
The Commission recognizes that there is an ongoing paperwork burden cost associated with adding the "short exempt" category and extending the marking requirement to all equity securities. The paperwork burden is estimated to be approximately 31 burden hours for each active broker-dealer registered with the Commission.140
We do not believe the new order marking requirements will impose additional monitoring or surveillance costs for registered broker-dealers. Registered broker-dealers already have established systems in place to comply with current SRO rules.
The Commission estimates that little to no costs will arise from the requirement that sell orders be marked long only in cases where the securities to be sold are owned by the customer and either are presently, or reasonably expected to be, in the customer's account prior to settlement. Most customer securities are not held by investors in physical form, but rather are held indirectly through their broker-dealer in "street name." Furthermore, commenters did not indicate any significant burden associated with the requirement.
2. Rule 202T: Pilot
Rule 202T establishes procedures for the Commission to temporarily suspend the trading restrictions of the Commission's short sale price test, as well as any short sale price test of any exchange or national securities association, for short sales in such securities as the Commission designates by order as necessary or appropriate in the public interest and consistent with the protection of investors after giving due consideration to the security's liquidity, volatility, market depth and trading market.
a. Benefits
We believe establishing procedures for the Commission to adopt a pilot pursuant to Rule 202T is an essential component of evaluating the overall effectiveness of price test restrictions on short sales. Any such pilot would be intended to: provide data on the impact of short selling in the absence of a price test; study the effects of relatively unrestricted short selling on market volatility, price efficiency, and liquidity; and obtain empirical data to help us assess whether a price test is necessary to further the objectives of short sale regulation and whether short sale price tests should be removed, in part or in whole, for actively traded securities or for all securities, or if retained, whether it should be extended to securities for which there currently is no price test.
We believe that there will be both short-term and long-term benefits from any such pilot. In the short-term, the removal of the price test for a specified period would immediately ease restrictions on short sales and might benefit investors and the markets without necessarily compromising the policy goals that a prophylactic price test is designed to address. Removing such restrictions could facilitate market participants' hedging activities in the securities included in the pilot, and might facilitate short selling that increases market liquidity and pricing efficiency. Short selling in the absence of a price test might increase the number of shares available to purchasers and reduce the risk that the price paid by investors is artificially high because of a temporary contraction of selling interest due to short sale price restrictions.
In the long-term, a pilot would allow the Commission to obtain empirical data necessary to consider alternatives, such as eliminating a Commission mandated price test for an appropriate group of securities, which may be all securities; adopting a uniform bid test, possibly extended to securities for which there is currently no price test; or leaving in place the current price tests. Historically, the possibility of considering such alternatives has been hampered by a lack of data concerning short selling, particularly with regard to listed-securities. Without empirical data relating to short selling in the absence of a price test in today's market, we believe that only broad conclusions could be derived with respect to the general impact of such short selling. Consequently, we believe that it is beneficial to establish a pilot to obtain empirical data in order to assist us in ascertaining whether to implement a price test, in whole or in part, for short sales in some or all securities, including securities not currently subject to any price test.
b. Costs
As an aid in evaluating costs, we sought comment in the Proposing Release concerning the public's views as well as any supporting information. Specifically, we sought detailed comment on the extent of required system changes and costs associated with implementation of a pilot program. Many industry commenters favored the creation of a pilot.141 Operation of the pilot could cause additional costs to brokers, dealers, SROs, and potentially to issuers and investors. SROs and broker-dealers might need to make system changes in order to exclude the selected securities from the Commission's tick test as well as any SRO price test.
Based on comments from the industry, we estimate that a pilot established under Rule 202T could require broker-dealer firms to reconfigure systems that currently set price test restrictions on short sales, which could impose modest costs. We anticipate that firms would have to remove existing price test restrictions for short sales of specified securities. The implementation of these modifications would require a readily identifiable, one-time adjustment. Market participants already remove the NASD's short sale rule, Rule 3350, after traditional market hours, as it is not applicable during that time,142 so application of any pilot to Nasdaq securities would not likely require the development of any new programs or surveillance systems.
Some commenters expressed a concern about pilot-related costs borne by issuers. According to these commenters, these costs could arise from possible manipulative short selling in the absence of price restrictions or pricing anomalies between securities in the same industry subject to a pilot and similar securities not subject to the price test. These commenters also asserted that a pilot might create a confusing system that will slow trading, lead to errors and confound market participants.
Most of the more liquid securities that would be appropriate for a pilot are traded on exchanges or other organized markets with high levels of transparency and surveillance. This would enhance the ability of the Commission and SROs to monitor trading behavior during the operation of any pilot and to surveil for manipulative short selling.143 More over, the general anti-fraud and anti-manipulation provisions of the federal securities laws would continue to apply to trading activity in these securities, thus prohibiting trading activity designed to improperly influence the price of a security.144 To the extent there are price and trading activity variations, this is precisely the empirical data that the Commission seeks to obtain and analyze as part of our assessment as to whether the price test should be removed, in part or whole, for pilot securities or other securities. In addition, a pilot would suspend only the operation of the price test, while the other requirements of Regulation SHO, including the order marking, locate and delivery requirements, would remain in effect.
The Commission, by further order, can terminate or extend the period of a pilot, remove or add some or all securities selected for a pilot as it determines necessary or appropriate in the public interest or to protect investors. Thus, costs associated with any manipulative short selling or price variations may be ameliorated through the termination of the pilot or removal of affected securities.
3. Rule 203: Locate and Delivery Requirements for Short Sales
a. Benefits
As adopted, Rule 203(b) creates a uniform Commission rule requiring broker-dealers to follow specified procedures for short sellers in all equity securities, wherever traded. Rule 203(b) requires that, prior to effecting short sales in all equity securities, broker-dealers must "locate" securities available for borrowing. This uniform rule furthers the goals of regulatory simplification and avoidance of regulatory arbitrage. Specifically, Rule 203(b) prohibits a broker-dealer from executing a short sale in any equity security, for the broker-dealer's own account or the account of another person, unless the broker-dealer has (1) borrowed the security, or entered into an arrangement to borrow the security, or (2) has reasonable grounds to believe that the security can be borrowed so that it can be delivered on the date delivery is due. Rule 203 requires that the locate be made and documented prior to effecting any short sale, regardless of whether the seller's short position may be closed out by purchasing securities the same day. The Commission has also adopted additional requirements targeted at "threshold securities" that have a substantial amount of failures to deliver, i.e., any equity security of an issuer registered under Section 12 or required to file reports under Section 15 of the Exchange Act where there are fails to deliver at a registered clearing agency of 10,000 shares or more per security; that the level of fails is equal to at least one-half of one percent of the issue's total shares outstanding; and the security is included on a list published by an SRO. In order to be subject to the restrictions of Rule 203, a security must exceed the designated level of fails for a period of five consecutive settlement days. Similarly, in order to be removed from the list of threshold securities, a security must not exceed the threshold for a period of five consecutive settlement days.
A broker-dealer is required to take additional steps should a fail in a threshold security remain 10 days after the normal settlement date, i.e., for 13 consecutive settlement days. Specifically, Rule 203(b)(3) requires the participant of a registered clearing agency to take action to close out the fail to deliver by purchasing securities of like kind and quantity.
The new locate and delivery requirements will protect and enhance the operation, integrity, and stability of the markets. For example, the requirements of Rule 203 include securities with lower market capitalization that may be more susceptible to abuse. Also, adopting uniform rules will further the goals of regulatory simplification and avoidance of regulatory arbitrage, as well as assist the Commission in its enforcement efforts regarding naked short selling activity. Certain issuers have taken steps to make their securities either "certificate only," which require physical certification of company ownership for all share transfers, or "custody only," which restricts ownership of their securities by depositories or financial intermediaries, which they assert has been done to avoid the effects of naked short selling of their securities. These custody arrangements are highly costly to the clearing agencies, depositories and financial intermediaries. Imposing a requirement to close-out large fails at the clearing level may decrease costs on the clearing agency by reducing the requests for "certificate only" issues.145 .
b. Costs
The Commission recognizes that locate and delivery requirements may increase costs for some market participants who engage in short selling. The Commission is, however, including an exception from the locate requirements of Rule 203(b)(1) for short sales executed by market makers in connection with bona-fide market making activities. In addition, any costs that initially may be incurred should be mitigated over time because the uniform rule should lead to regulatory simplification with regard to training and surveillance.
The rule includes certain exceptions from the locate requirement, which mitigate many associated cost burdens. The rule provides an exception for bona-fide market making. This exception covers short sales executed by market makers, including specialists and options market makers, in connection with bona-fide market making activities. Excepting bona-fide market making activity from the locate requirement will benefit investors and the market by preserving necessary market liquidity.
A second exception is for broker-dealers that receive a short sale order from another registered broker-dealer that is required to have already complied with Rule 203(b)(1). This exception relieves the executing broker-dealer from engaging in a second locate for the transaction. This exception limits the possibility of over borrowing as well as any delay in execution.
A third exception to the locate requirement covers situations where a broker effects a sale on behalf of a customer who owns the security pursuant to Rule 200, but through no fault of the customer or broker-dealer, it is not reasonably expected that the security will be in the possession or control of the broker-dealer by settlement date. Under the newly adopted marking requirement, this sale would be marked "short." Such situations could include where a convertible security, option, or warrant has been tendered for conversion, but the underlying security is not reasonably expected to be received by settlement date.
There may be costs associated with implementing these locate requirements for OTCBB and Pink Sheet securities. For example, a number of commenters noted that there might not be a broad pool of lendable securities in such issuers, due to the inability of firms to hypothecate shares bought on margin, and due to the absence of institutional lenders in these securities. This could affect the ability of these small issuers to obtain financing through the issuance of convertible debentures, in that market participants that buy these convertible debentures may not be able to sell short for hedging purposes if they are unable to locate the issuer's securities.
In addition, other commenters also noted that, due to the absence of stock available for borrowing in these issuers, requiring short sellers to locate such securities could essentially remove the ability to take short positions in these stocks, and would help to facilitate issuers, promoters, or other shareholders that may be attempting to manipulatively push up the company's stock price. These commenters noted their belief that some issuers and their associated stock promoters may also be using the recent controversy over naked short selling to engage in fraud, or otherwise distract investors from fundamental problems with the company.
It is the Commission's belief that removing all restrictions on the ability to effect naked short sales is not the proper recourse against potential issuer fraud, as it may simply encourage another type of manipulation or exacerbate other potentially negative consequences associated with large failures to deliver. Nevertheless, the Commission is cognizant of these concerns and is taking action to combat such activities. For example, the Commission continues to bring enforcement actions for issuer fraud, including actions against some of the companies that have claimed to be "victims" of naked short selling.146 In addition, the Commission recently proposed other steps to protect investors by deterring fraud and abuse in the securities markets through the use of "shell companies."147
The greatest costs associated with Rule 203's requirements relate to controlling failures in threshold securities.148 Participants of a registered clearing agency, broker-dealers, market makers, and SROs may incur costs in making initial system changes necessary to implement these new requirements, as well as maintaining ongoing compliance and surveillance mechanisms. Comments from the industry maintained that any one-time programming costs would be "manageable" or "nominal."149 Since NSCC already provides to the SROs information on all issuers that have fails to deliver in excess of 10,000 shares, this will mitigate any cost burdens on accessing the information. Furthermore, this information can be matched with the readily available information on an issuer's total shares outstanding to determine whether the security meets the definition of a threshold security under Regulation SHO.
However, some industry sources argued that the ongoing cost of requiring broker-dealers, including market makers,150 to borrow or arrange to borrow for future short sales if there was not compliance with the requirement to close-out fails to deliver in threshold securities would decrease liquidity, impose large borrowing costs and execution delay. Also, some commenters, including options market makers and options exchanges, noted that if we do not include such an exception would be to cease altogether options trading in securities that are difficult to borrow, as it was argued that no options market maker would make markets without the ability to hedge.
We note that the close out requirements of Rule 203(b)(3) will only apply to short sales in securities that meet the designated threshold level of fails, and similar to the current operation of NASD Rule 11830, will not apply to any short sales effected prior to the security meeting the threshold. We have noted the above concerns, but believe that they may be exaggerated, especially considering that OEA has estimated that threshold securities represent approximately 4% of the equities markets.151 Also, any cost estimates related to the narrowly applied borrowing requirement appear extremely speculative.152 In light of this, we do not expect that excluding a market maker exception from the close out requirement of Rule 203(b)(3) would have such adverse consequences.
4. Rule 203: Requirements for Long Sales
Rule 203(a) incorporates Rule 10a-2, which covered delivery requirements applicable to long sales of securities registered or admitted to unlisted trading privileges on a national securities exchange. As adopted, Rule 203(a) generally provides that if a broker-dealer knows or should know that a sale is marked long, the broker-dealer must make delivery when due and cannot use borrowed securities to do so.153 Rule 203(a) extends these delivery requirements to all securities, including those not registered on an exchange. In addition, Rule 203(a) makes clear that a broker or dealer may not fail to deliver, nor may it loan securities for delivery on a sale marked "long," unless, prior to the sale, the broker or dealer knew that the seller owned the securities and the seller represented that he would deliver them to the broker in time for settlement but failed to do so.
a. Benefits
Extending the long sale delivery requirements to all securities will benefit investors and the markets, because as with short sales, delivery requirements are important in securities with lower market capitalization that may be more susceptible to abuse. Moreover, Rule 203(a) states that a broker-dealer cannot fail or loan shares on a long sale unless, in advance of the sale, the broker-dealer ascertains that the customer owned the shares. This change, together with changes being made to the long sale order marking requirements, provide an important benefit to the market by making clear a broker's obligation to confirm the long seller's ownership of the shares prior to executing the sale.
b. Costs
Although we sought public comment on costs, we did not receive any comments relating to Rule 203(a). We recognize that there may be some costs associated with extending the delivery requirements to all securities, including costs related to system changes and surveillance. However, since market participants already must comply with the current language of Rule 10a-2, we expect any costs will be nominal. The benefit of a uniform delivery scheme for long sales justifies any costs that will be incurred by market participants.
5. Rule 105 of Regulation M
Rule 105 of Regulation M prohibits a short seller from covering short sales with offering securities purchased from an underwriter, broker or dealer participating in the offering if the short sale occurred during the Rule's restricted period, typically the five-day period prior to pricing. The reason for the prohibition is that pre-pricing short sales that are covered with offering shares artificially distorts the market price for the security, preventing the market from functioning as an independent pricing mechanism and eroding the integrity of the offering price. The goal of Rule 105 is to promote offering prices that are based upon open market prices determined by supply and demand rather than artificial forces. The Rule is prophylactic, and prohibits the conduct irrespective of the short seller's intent in effecting the short sale.
Typically, follow-on offering prices are based on a stock's closing price prior to pricing, and thus short sales during the period immediately preceding pricing that reduce the market price can result in a lower offering price. Rule 105 does not prohibit pre-pricing short sales, but it does prevent short sellers from covering the short sales with offering shares. A trader who sells short pre-pricing because the trader knows or has a high degree of certainty that he or she will be able to obtain covering shares in the offering at a lower price does not assume the same market risk as a short seller who intends to cover with open market shares and is not engaged in an evaluation of the stock's "true value." This manipulative conduct can negatively impact the issuer, which receives reduced offering proceeds as a result of the lower offering price, and harms the market by inhibiting the capital raising process.
The adopted amendments to Rule 105 eliminate the shelf offering exception. At the time of adoption of the exception, the Commission viewed shelf offerings as uncommon and generally less susceptible to manipulation than non-shelf offerings.154 Today, shelf offerings are common, and investors generally have notice of them before they occur because they are likely to utilize the same marketing efforts -- road shows and other selling efforts -- that are used with non-shelf offerings.
a. Benefits
Eliminating the shelf exception from Rule 105 will provide a number of important benefits to issuers, investors, and the market as a whole. The amendment updates Rule 105 by adopting a uniform standard for shelf and non-shelf offerings, which are much more similar today than when the exception was adopted because of changes in the way most shelf offerings are sold. Both shelf and non-shelf offerings are susceptible to the manipulation that Rule 105 is intended to prevent. In both cases, pre-pricing short sales that are covered with offering shares exert downward pressure on pricing that is not connected to any evaluation of the stock's future performance.
Elimination of the shelf exception will benefit issuers and investors by promoting shelf-offering prices that are based upon market prices that are not artificially influenced. This will safeguard the integrity of the capital raising process with respect to shelf offerings and enhance investor confidence in our markets. The amended rule will also protect issuers conducting shelf offerings from receiving reduced offering proceeds as a result of manipulative conduct.
b. Costs
We recognize that the amendments to Rule 105 may result in some costs to certain market participants. Eliminating the shelf exception may impair a short seller's ability to effect a covering transaction because there are fewer shares available with which one may cover. It may also impact traders and firms that derive significant revenue from covering pre-pricing shorts with shelf offering shares.
We anticipate these changes to Rule 105 may impose compliance costs, in the form of increased surveillance, on broker-dealers. However, we do not expect the change to result in a major increase in costs or prices for consumers or individual industries. Rather, the change will curtail the potential for manipulative activity that might otherwise create a temporary mispricing of securities and reduce offering proceeds. The change will provide a protective measure against abusive conduct that hampers the capital raising process and negatively impacts issuers.
Any costs associated with restricting a short sellers' ability to cover with offering shares is balanced by the benefits derived from preventing the manipulative activity of effecting pre-pricing short sales and covering with offering shares. Moreover, although the Commission recognizes that the amendments may diminish a short seller's ability to effect a covering transaction by restricting the sources from which he may cover, Rule 105 will continue to allow the beneficial effects of short selling to reach the market. Short selling in advance of a shelf offering will remain available to enhance pricing efficiency.
Lastly, the amendments to Rule 105 of Regulation M do not impose a ban on pre-pricing short sales. Rather, the amendments prohibit short sellers from covering the short sales with offering shares. The amendments will prevent a trader who sells short pre-pricing because the trader knows he or she will obtain offering shares to cover the short position at a lower price in order to generate a risk-free profit.
X. Consideration of Promotion of Efficiency, Competition, and Capital Formation
Section 3(f) of the Exchange Act155 requires us, when engaging in rulemaking and where we are required to consider or determine whether an action is necessary or appropriate in the public interest, to consider, in addition to the protection of investors, whether the action will promote efficiency, competition, and capital formation. Section 23(a)(2) of the Exchange Act156 requires the Commission in adopting rules under the Exchange Act, to consider the anticompetitive effects of any rules it adopts under the Exchange Act. Section 23(a)(2) prohibits us from adopting any rule that would impose a burden on competition not necessary or appropriate in furtherance of the purposes of the Exchange Act. In the Proposing Release, we solicited comment on the proposals' effects on efficiency, competition, and capital formation. Additionally we requested, but did not receive, comments regarding the impact of the proposed amendments on the economy generally pursuant to the Small Business Regulatory Enforcement Fairness Act of 1996.157
We have considered the proposed amendments in Regulation SHO in light of the standards of Section 23(a)(2) of the Exchange Act and believe the adopted amendments should not impose any burden on competition not necessary or appropriate in furtherance of the Exchange Act. We note, however, that there are several areas in Regulation SHO where issuers may be treated differently.
First, in any pilot created pursuant to Rule 202T, the price test could be suspended for issuers selected, while the price test would continue to apply to issuers in the same industry that are not selected for the pilot. Some commenters expressed a concern about the pilot imposing costs on issuers selected, relative to possible manipulative short selling in the absence of price restrictions or pricing anomalies. These commenters also asserted that the pilot would create a confusing system that would slow trading, lead to errors, and confound market participants.
We believe that most of the more liquid securities that would be appropriate for a pilot are traded on exchanges or other organized markets with high level of transparency and surveillance. The Commission and SROs would monitor trading behavior during the operation of any pilot and surveil for manipulative short selling activity. Furthermore, the general anti-fraud and anti-manipulation provisions of the federal securities laws will continue to apply to trading activity in these securities, thus prohibiting trading activity designed to improperly influence the price of a security.158 Moreover, to the extent there are price and trading activity variations, this is precisely the empirical data that the Commission seeks to obtain and analyze as part of our assessment as to whether the price test should be removed, in part or whole, for the pilot securities or other securities.
By further order, the Commission can terminate or extend the period of the pilot as it determines necessary or appropriate in the public interest or to protect investors or to remove or add some or all securities selected for the pilot, any costs associated with manipulative short selling or price variations may be ameliorated through the termination of the pilot or removal of affected securities.
Secondly, the additional requirements of Rule 203(b)(3) will apply to any equity security of an issuer registered under Section 12 or required to file reports pursuant to Section 15 of the Exchange Act where, for five consecutive settlement days, there are fails to deliver at a registered clearing agency of 10,000 shares or more per security, and that is equal to at least one-half of one percent of the issue's total shares outstanding. The additional requirements will not apply to any issuers that are not registered under Section 12 or required to file reports pursuant to Section 15 of the Exchange Act, and are thus not required to provide ongoing public disclosure about the company, its actions, and its performance. As the calculation of the threshold that would trigger the requirements of Rule 203(b)(3) depends on identifying the aggregate fails to deliver as a percentage of the issuer's total shares outstanding, it is necessary to limit the requirement to companies that are subject to the reporting requirements of the Exchange Act.
XI. Final Regulatory Flexibility Analysis
The Final Regulatory Flexibility Analysis ("FRFA") has been prepared in accordance with the Regulatory Flexibility Act.159 This FRFA relates to new Regulation SHO, adopted under the Exchange Act, which replaces Rules 3b-3 and 10a-2, and amends Rule 105 of Regulation M.
Rule 200 of Regulation SHO defines ownership of securities, specifies aggregation of long and short positions, and also includes the requirement that sales in all equity securities be marked "long," "short," or "short exempt." Regulation SHO includes a temporary rule, Rule 202T, that establishes procedures to allow the Commission to suspend the operation of the current "tick" test in Rule 10a-1, and any short sale price test for any exchange or national securities association, for specified securities. Rule 203 of Regulation SHO requires short sellers in all equity securities to locate securities to borrow before selling, and also imposes heightened delivery requirements on securities that have fails to deliver at a registered clearing agency of 10,000 shares or more per security, and that is equal to at least one-half of one percent of the issues total shares outstanding. The Commission is also adopting amendments to Rule 105 of Regulation M to remove the shelf offering exception.
A. Need for and Objectives of the Amendments
Regulation SHO and the amendments to Rule 105of Regulation M are designed, in part, to fulfill several objectives, including: (1) establish uniform locate and delivery requirements in order to address potentially abusive naked short selling and other problems associated with failures to deliver; (2) clarify marking requirements for short sales in all equity securities; (3) establish a procedure to temporarily suspend Commission and SRO short sale price tests in order to evaluate the overall effectiveness and necessity of such restrictions; and (4) prohibit certain short sales from being covered with securities obtained from shelf offerings.
Moreover, the rules are consistent with the objective of simplifying and modernizing short sale regulation, providing controls where they are most needed, and temporarily removing restrictions where they may be unnecessary. Rule 203(b) of Regulation SHO provides stronger locate and delivery requirements designed to address abusive naked short selling, i.e., a security could only be sold short to the extent that there was stock available to borrow. Rule 203 is a targeted approach that incorporates the provisions of existing SRO rules while imposing additional restrictions where we believe appropriate to address naked short selling while protecting and enhancing the operation, integrity, and stability of the markets. As a part of this effort to improve locate and delivery requirements, Rule 200 clarifies marking requirements and thus clarifies when a participant must locate stocks for delivery. Rule 202T establishes procedures for the Commission to temporarily remove price restrictions for short sales from certain securities so that we can obtain empirical data on the impact of short selling in the absence of a price test and to assess whether a short sale price test should be removed, in part or in whole, for some or all securities.
The amendments to Rule 105 of Regulation M prohibit covering certain short sales with securities acquired in a shelf offering. The amendments are in response to the recognition that shelf offerings are much more common in today's markets and with increased transparency they are susceptible to the same potential for manipulation and abuse as non-shelf offerings. The elimination of the shelf offering exception in Rule 105 is designed to reduce the potential that pre-pricing short sales will exert downward price pressure on the market price of a shelf offering.
B. Significant Issues Raised by Public Comments
The Initial Regulatory Flexibility Analysis ("IRFA") appeared in the Proposing Release.160 We requested comment in the IRFA on the impact the proposals would have on small entities and how to quantify the impact. We did not receive any comment letters addressing the IRFA; however, a few commenters discussed certain costs that would be incurred by small broker-dealers and issuers if some or all of the proposals in Regulation SHO were adopted.161
C. Small Entities Subject to the Amendments
Paragraph (c)(1) of Rule 0-10162 states that the term "small business" or "small organization," when referring to a broker-dealer, means a broker or dealer that had total capital (net worth plus subordinated liabilities) of less than $500,000 on the date in the prior fiscal year as of which its audited financial statements were prepared pursuant to §240.17a-5(d); and that is not affiliated with any person (other than a natural person) that is not a small business or small organization. In the IRFA of the Proposing Release, we estimated that as of 2002 there were approximately 880 broker dealers that qualified as small entities, as defined above. Presently, we estimate that as of 2003 there are approximately 906 broker-dealers that qualify as small entities, as defined above.
In the Proposing Release, we sought comment on the costs on small entities to modify, and in some cases install, systems and surveillance mechanisms to ensure compliance with the new rules, including implementing the pilot, marking, and locate and delivery requirements. No commenters responded with cost estimates pertaining to the requested data listed above. Nevertheless, we estimate the costs related to upgrades of systems and surveillance mechanisms will be minimal. Industry sources stated that most broker-dealers, including small broker-dealers, already have the necessary systems in place. Therefore, such entities will only be required to modify their systems for compliance.
D. Projected Reporting, Recordkeeping, and other Compliance Requirements
Regulation SHO may impose some new compliance and marking requirements on broker-dealers that are small entities. Some small entities that trade securities that may be subject to the pilot program will have to make changes to exclude these securities from Commission and SRO price test restrictions. Moreover, small entities may have to make systems changes for additional marking requirements for short sales in listed securities, i.e., adding a "short exempt" designation.163
We sought comment on the reporting, recordkeeping, and compliance costs on small entities with regard to, among other things, implementing the pilot and the marking requirements. We estimate that the greatest cost associated with such requirements is related to implementation time and training.
E. Agency Action to Minimize the Effect on Small Entities
As required by the Regulatory Flexibility Act, we have considered alternatives that would accomplish our stated objectives, while minimizing any significant adverse impact on small entities. Several alternatives were considered but rejected, while other alternatives were taken into account in the adoption of Regulation SHO and the amendments to Rule 105 of Regulation M. The final rules and rule amendments meet the Commission's stated goals by applying short sale restrictions where they are most needed and easing them, on a temporary basis to obtain greater empirical data, where they may be unnecessary.
Regulation SHO and the amendments to Rule 105 of Regulation M should not adversely affect small entities because they impose minimal new reporting, record keeping or compliance requirements. Moreover, it is not appropriate to develop separate requirements for small entities with respect to Regulation SHO and the adopted amendments to Rule 105 of Regulation M, because we think all issuers, including issuers that are small entities, should be subject to short sale locate and delivery requirements, marking requirements, and the easing of restrictions on short sales subject of the pilot. As stated in the Proposing Release, we believe that it is beneficial to establish uniform standards specifying procedures for all short selling.
XII. Statutory Basis and Text of Adopted Amendments
Pursuant to the Exchange Act and, particularly, Sections 2, 3(b), 9(h), 10, 11A, 15, 17(a), 17A, 23(a), and 36 thereof, 15 U.S.C. 78b, 78c(b), 78i(h), 78j, 78k-1, 78o, 78q(a), 78q-1, 78w(a), and 78mm, the Commission is adopting §§ 242.200, 242.202T, 242.203, along with amendments to Regulation M, Rule 105, and interpretative guidance set forth in part 241.
List of Subjects
17 CFR Parts 240 and 242
Brokers, Fraud, Reporting and recordkeeping requirements, Securities.
17 CFR Part 241
Securities.
For the reasons set out in the preamble, Title 17, Chapter II, of the Code of Federal Regulations is amended as follows.
PART 240 — GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 1934
1. The authority citation for part 240 continues to read in part as follows:
Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3, 77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i, 78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78q-1, 78s, 78u-5, 78w, 78x, 78ll, 78mm, 79q, 79t, 80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 80b-11, and 7201 et seq.; and 18 U.S.C. 1350, unless otherwise noted.
* * * * *
2. Sections 240.3b-3 and 240.10a-2 are removed and reserved.
3. Section 240.10a-1 is amended by:
a. Removing the authority citations following the section;
b. Removing and reserving paragraphs (c) and (d); and
c. Removing paragraph (e)(13).
PART 241 — INTERPRETATIVE RELEASES RELATING TO THE SECURITIES EXCHANGE ACT OF 1934 AND GENERAL RULES AND REGULATIONS THEREUNDER.
4. Part 241 is amended by adding Release No. 34-50103 and the release date of July 28, 2004 to the list of interpretive releases.
PART 242 — REGULATIONS M, SHO, ATS, AND AC AND CUSTOMER MARGIN REQUIREMENTS FOR SECURITY FUTURES
5. The authority citation for part 242 continues to read as follows:
Authority: 15 U.S.C. 77g, 77q(a), 77s(a), 78b, 78c, 78g(c)(2), 78i(a), 78j, 78k-1(c), 78l, 78m, 78mm, 78n, 78o(b), 78o(c), 78o(g), 78q(a), 78q(b), 78g(h), 78w(a), 78dd-1, 80a-23, 80a-29, and 80a-37.
6. The part heading for part 242 is revised as set forth above.
7. Section 242.105, paragraph (b) is amended by removing the phrase "offerings filed under §230.415 of this chapter or to".
8. Part 242 is amended by adding §§ 242.200 through 242.203 to read as follows:
Regulation SHO — Regulation of Short Sales
Sec.
242.200 Definition of "short sale" and marking requirements.
242.201 Price test [Reserved].
242.202T Temporary short sale rule suspension.
242.203 Borrowing and delivery requirements.
Regulation SHO — Regulation of Short Sales
§ 242.200 Definition of "short sale" and marking requirements.
(a) The term short sale shall mean any sale of a security which the seller does not own or any sale which is consummated by the delivery of a security borrowed by, or for the account of, the seller.
(b) A person shall be deemed to own a security if:
(1) The person or his agent has title to it; or
(2) The person has purchased, or has entered into an unconditional contract, binding on both parties thereto, to purchase it, but has not yet received it; or
(3) The person owns a security convertible into or exchangeable for it and has tendered such security for conversion or exchange; or
(4) The person has an option to purchase or acquire it and has exercised such option; or
(5) The person has rights or warrants to subscribe to it and has exercised such rights or warrants; or
(6) The person holds a security futures contract to purchase it and has received notice that the position will be physically settled and is irrevocably bound to receive the underlying security.
(c) A person shall be deemed to own securities only to the extent that he has a net long position in such securities.
(d) A broker or dealer shall be deemed to own a security, even if it is not net long, if:
(1) The broker or dealer acquired that security while acting in the capacity of a block positioner; and
(2) If and to the extent that the broker or dealer's short position in the security is the subject of offsetting positions created in the course of bona fide arbitrage, risk arbitrage, or bona fide hedge activities.
(e) A broker-dealer shall be deemed to own a security even if it is not net long, if:
(1) The broker-dealer is unwinding index arbitrage position involving a long basket of stock and one or more short index futures traded on a board of trade or one or more standardized options contracts as defined in 17 CFR 240.9b-1(a)(4); and
(2) If and to the extent that the broker-dealer's short position in the security is the subject of offsetting positions created and maintained in the course of bona-fide arbitrage, risk arbitrage, or bona fide hedge activities; and
(3) The sale does not occur during a period commencing at the time that the Dow Jones Industrial Average has declined by two percent or more from its closing value on the previous day and terminating upon the establishment of the closing value of the Dow Jones Industrial Average on the next succeeding trading day.
(f) In order to determine its net position, a broker or dealer shall aggregate all of its positions in a security unless it qualifies for independent trading unit aggregation, in which case each independent trading unit shall aggregate all of its positions in a security to determine its net position. Independent trading unit aggregation is available only if:
(1) The broker or dealer has a written plan of organization that identifies each aggregation unit, specifies its trading objective(s), and supports its independent identity;
(2) Each aggregation unit within the firm determines, at the time of each sale, its net position for every security that it trades;
(3) All traders in an aggregation unit pursue only the particular
trading objective(s) or strategy(s) of that aggregation unit and do not coordinate that strategy with any other aggregation unit; and
(4) Individual traders are assigned to only one aggregation unit at any time.
(g) A broker or dealer must mark all sell orders of any security as "long,"
"short," or "short exempt."
(1) An order to sell shall be marked "long" only if the seller is deemed to own the security being sold pursuant to paragraphs (a) through (f) of this section and either:(i) The security to be delivered is in the physical possession or control of the broker or dealer; or
(ii) It is reasonably expected that the security will be in the physical possession or control of the broker or dealer no later than the settlement of the transaction.
(2) A short sale order shall be marked "short exempt" if the seller is relying on an exception from the tick test of 17 CFR 240.10a-1, or any short sale price test of any exchange or national securities association.
(h) Upon written application or upon its own motion, the Commission may grant an exemption from the provisions of this section, either unconditionally or on specified terms and conditions, to any transaction or class of transactions, or to any security or class of securities, or to any person or class of persons.
§ 242.201 Price test [Reserved].
§ 242.202T Temporary short sale rule suspension.
(a) The provisions of 17 CFR 240.10a-1(a) and any short sale price test for any exchange or national securities association shall not apply to short sales in such securities, or during such time periods, as the Commission designates by order as necessary or appropriate in the public interest and consistent with the protection of investors after giving due consideration to the security's liquidity, volatility, market depth and trading market. All other provisions of 17 CFR 240.10a-1, §242.200, and §242.203 shall remain in effect.
(b) No self-regulatory organization shall have a rule that is not in conformity with or conflicts with any order issued pursuant to paragraph (a) of this section.
(c) This temporary section will expire on [insert date three years after publication in the Federal Register].
§ 242.203 Borrowing and delivery requirements.
(a) Long sales. (1) If a broker or dealer knows or has reasonable grounds to believe that the sale of an equity security was or will be effected pursuant to an order marked "long," such broker or dealer shall not lend or arrange for the loan of any security for delivery to the purchaser's broker after the sale, or fail to deliver a security on the date delivery is due.
(2) The provisions of paragraph (a)(1) of this section shall not apply:
(i) To the loan of any security by a broker or dealer through the medium of a loan to another broker or dealer;
(ii) If the broker or dealer knows, or has been reasonably informed by the seller, that the seller owns the security, and that the seller would deliver the security to the broker or dealer prior to the scheduled settlement of the transaction, but the seller failed to do so; or
(iii) If, prior to any loan or arrangement to loan any security for delivery, or failure to deliver, a national securities exchange, in the case of a sale effected thereon, or a national securities association, in the case of a sale not effected on an exchange, finds:
(A) That such sale resulted from a mistake made in good faith;
(B) That due diligence was used to ascertain that the circumstances specified in §242.200(g) existed; and
(C) Either that the condition of the market at the time the mistake was discovered was such that undue hardship would result from covering the transaction by a "purchase for cash" or that the mistake was made by the seller's broker and the sale was at a permissible price under any applicable short sale price test.
(b) Short sales. (1) A broker or dealer may not accept a short sale order in an equity security from another person, or effect a short sale in an equity security for its own account, unless the broker or dealer has:
(i) Borrowed the security, or entered into a bona-fide arrangement to borrow the security; or
(ii) Reasonable grounds to believe that the security can be borrowed so that it can be delivered on the date delivery is due; and
(iii) Documented compliance with this paragraph (b)(1).
(2) The provisions of paragraph (b)(1) of this section shall not apply to:
(i) A broker or dealer that has accepted a short sale order from another registered broker or dealer that is required to comply with paragraph (b)(1) of this section, unless the broker or dealer relying on this exception contractually undertook responsibility for compliance with paragraph (b)(1) of this section;
(ii) Any sale of a security that a person is deemed to own pursuant to §242.200, provided that the broker or dealer has been reasonably informed that the person intends to deliver such security as soon as all restrictions on delivery have been removed. If the person has not delivered such security within 35 days after the trade date, the broker-dealer that effected the sale must borrow securities or close out the short position by purchasing securities of like kind and quantity;
(iii) Short sales effected by a market maker in connection with bona-fide market making activities in the security for which this exception is claimed; and
(iv) Transactions in security futures.
(3) If a participant of a registered clearing agency has a fail to deliver position at a registered clearing agency in a threshold security for thirteen consecutive settlement days, the participant shall immediately thereafter close out the fail to deliver position by purchasing securities of like kind and quantity:
(i) The provisions of this paragraph (b)(3) shall not apply to the amount of the fail to deliver position that the participant of a registered clearing agency had at a registered clearing agency on the settlement day immediately preceding the day that the security became a threshold security; provided, however, that if the fail to deliver position at the clearing agency is subsequently reduced below the fail to deliver position on the settlement day immediately preceding the day that the security became a threshold security, then the fail to deliver position excepted by this paragraph (b)(3)(i) shall be the lesser amount;
(ii) The provisions of this paragraph (b)(3) shall not apply to the amount of the fail to deliver position in the threshold security that is attributed to short sales by a registered options market maker, if and to the extent that the short sales are effected by the registered options market maker to establish or maintain a hedge on options positions that were created before the security became a threshold security;
(iii) If a participant of a registered clearing agency has a fail to deliver position at a registered clearing agency in a threshold security for thirteen consecutive settlement days, the participant and any broker or dealer for which it clears transactions, including any market maker that would otherwise be entitled to rely on the exception provided in paragraph (b)(2)(iii) of this section, may not accept a short sale order in the threshold security from another person, or effect a short sale in the threshold security for its own account, without borrowing the security or entering into a bona-fide arrangement to borrow the security, until the participant closes out the fail to deliver position by purchasing securities of like kind and quantity;
(iv) If a participant of a registered clearing agency reasonably allocates a portion of a fail to deliver position to another registered broker or dealer for which it clears trades or for which it is responsible for settlement, based on such broker or dealer's short position, then the provisions of this paragraph (b)(3) relating to such fail to deliver position shall apply to the portion of such registered broker or dealer that was allocated the fail to deliver position, and not to the participant; and
(v) A participant of a registered clearing agency shall not be deemed to have fulfilled the requirements of this paragraph (b)(3) where the participant enters into an arrangement with another person to purchase securities as required by this paragraph (b)(3), and the participant knows or has reason to know that the other person will not deliver securities in settlement of the purchase.
(c) Definitions.
(1) For purposes of this section, the term market maker has the same meaning as in section 3(a)(38) of the Securities Exchange Act of 1934 ("Exchange Act") (15 U.S.C. 78c(a)(38)).
(2) For purposes of this section, the term participant has the same meaning as in section 3(a)(24) of the Exchange Act (15 U.S.C. 78c(a)(24)).
(3) For purposes of this section, the term registered clearing agency means a clearing agency, as defined in section 3(a)(23)(A) of the Exchange Act (15 U.S.C. 78c(a)(23)(A)), that is registered with the Commission pursuant to section 17A of the Exchange Act (15 U.S.C. 78q-1).
(4) For purposes of this section, the term security future has the same meaning as in section 3(a)(55) of the Exchange Act (15 U.S.C. 78c(a)(55)).
(5) For purposes of this section, the term settlement day means any business day on which deliveries of securities and payments of money may be made through the facilities of a registered clearing agency.
(6) For purposes of this section, the term threshold security means any equity security of an issuer that is registered pursuant to section 12 of the Exchange Act (15 U.S.C. 78l) or for which the issuer is required to file reports pursuant to section 15(d) of the Exchange Act (15 U.S.C. 78o(d)):
(i) For which there is an aggregate fail to deliver position for five consecutive settlement days at a registered clearing agency of 10,000 shares or more, and that is equal to at least 0.5% of the issue's total shares outstanding;
(ii) Is included on a list disseminated to its members by a self-regulatory organization; and
(iii) Provided, however, that a security shall cease to be a threshold security if the aggregate fail to deliver position at a registered clearing agency does not exceed the level specified in paragraph (c)(6)(i) of this section for five consecutive settlement days.
(d) Exemptive authority. Upon written application or upon its own motion, the Commission may grant an exemption from the provisions of this section, either unconditionally or on specified terms and conditions, to any transaction or class of transactions, or to any security or class of securities, or to any person or class of persons.
By the Commission.
Jill M. Peterson
Assistant Secretary
Dated: July 28, 2004
1 17 CFR 242.200 through 242.203.
2 17 CFR 242.105.
3 17 CFR 240.10a-1.
4 Securities Exchange Act Release No. 48709 (October 28, 2003), 68 FR 62972 (November 6, 2003)("Proposing Release").
5 The comment letters and a comprehensive summary of the comments are available for inspection in the Commission's Public Reference Room in File No. S7-23-03, or may be viewed at http://www.sec.gov/rules/proposed/s72303.shtml. The 438 different letters from 462 commenters reflect the number of different letters received; thus form letters, referred to as "letter types" on the Commission's Web site (www.sec.gov), counted as one letter. For example, 18 individuals sent Letter Type A, 21 individuals sent Letter Type B, 18 individuals sent Letter Type C, 19 individuals sent Letter Type D, two individuals sent Letter Type E, two individuals sent Letter Type F, 15 individuals sent Letter Type G, two individuals sent Letter Type H, 15 individuals sent Letter Type I, and four individuals sent Letter Type J. In addition, although submitted under Regulation SHO, Letter Types H, I, and J substantively refer to amendments to NASD Rule 3370. See Securities Exchange Act Release No. 49285 (February 19, 2004), 69 FR 8717 (February 25, 2004). They are included in the total here because commenters indicated that they were submitted in response to proposed Regulation SHO.
6 In adopting the tick test, the Commission sought to achieve three objectives: (i) allowing relatively unrestricted short selling in an advancing market; (ii) preventing short selling at successively lower prices, thus eliminating short selling as a tool for driving the market down; and (iii) preventing short sellers from accelerating a declining market by exhausting all remaining bids at one price level, causing successively lower prices to be established by long sellers. See Securities Exchange Act Release No. 13091 (December 21, 1976), 41 FR 56530 (December 28, 1976). As we stated in the Proposing Release, short selling provides the market with at least two important benefits: market liquidity and pricing efficiency. Proposing Release, 68 FR at 62974.
7 This marking requirement had been proposed in Rule 201(c). The marking requirements as adopted in Rule 200 apply to short sales in all equity securities, in contrast to paragraphs (c) and (d) of current Rule 10a-1, which only apply to exchange-listed securities.
8 Securities Exchange Act Release No. 50104 (July 28, 2004).
9 The Commission expects to make information obtained during the pilot publicly available.
10 "Naked" short selling, while not defined in the federal securities laws or SRO rules, generally refers to selling short without having borrowed the securities to make delivery.
11 Additionally, the Commission sought comment on an alternative price test that would allow short selling at a price equal to or above the consolidated best bid if the current best bid is above the previous bid (i.e., an upbid). Under this alternative, short selling would be restricted to a price at least one cent above the consolidated best bid if the current best bid is below the previous bid (i.e., a downbid).
12 The Specialist Association also argued for maintaining the current tick test on exchange-listed securities, and also opposed the proposed pilot program, arguing that it is likely to have unwarranted and unintended adverse effects on the securities included in the pilot, and could disadvantage these issuers compared to peer issuers that remain subject to the tick test.
13 The letter from the American Society of Corporate Secretaries ("ASCS"), an organization of corporate issuers, did not opine on the pilot or the proposed bid test, but rather focused exclusively on the effects of short selling on proxy voting. The Commission expects to determine at a future date whether to take action with regard to that issue.
14 See e.g., letter from The American Stock Exchange ("Amex"); letter from CHX. Amex estimated that it would take the exchange three and a half months to make the necessary surveillance changes and would cost roughly $125,000. CHX represented that the aggregate cost to the exchange and its floor members would amount to at least $500,000.
15 As a result, all existing exceptions and exemptions from Rule 10a-1 remain in effect. In addition, at this time, because we are not adopting the proposed uniform bid test, we have deferred a decision on our proposal to codify prior exemptive relief. See Proposing Release, Section VII.
16 Rule 3b-3 sets forth the definition of "short sale" and identifies the specific instances for determining a long position. 17 CFR 240.3b-3.
17 See Proposing Release, Section X.
18 See Commission Guidance on the Application of Certain Provisions of the Securities Act of 1933, the Securities Exchange Act of 1934, and Rules thereunder to Trading in Security Futures Products, Securities Exchange Act Release No. 46101 (June 21, 2002), 67 FR 43234 (June 27, 2002) ("Guidance Release").
19 Guidance Release at II.B.2.; Proposing Release at n. 179.
20 See letter from LEK Securities.
21 See Guidance Release.
22 Under Rule 3b-3, a seller of an equity security subject to Rule 10a-1 must aggregate all of its positions in that security in order to determine whether the seller has a "net long position" in the security. 17 CFR 240.3b-3. See also Securities Exchange Act Release No. 20230 (September 27, 1983), 48 FR 45119, 45120 (October 3, 1983) (to determine whether a person has a "net long position" in a security, all accounts must be aggregated); Securities Exchange Act Release No. 27938 (April 23, 1990), 55 FR 17949, 17950 (aggregation must be based on a listing of securities positions in all proprietary accounts as determined at least once each trading day).
23 1998 SEC No-Act LEXIS 1038 (November 23, 1998)(aggregation unit netting no-action letter).
24 For firms not relying on the aggregation unit exception, we understand that available technology allows firms to aggregate their firm-wide positions on a real-time basis. To the extent that a firm is unable to accomplish real-time aggregation on a firm-wide basis, it should be able to demonstrate why such aggregation is impracticable and that the alternative method employed (e.g., on a daily basis) accurately reflects firm ownership positions.
25 As noted in the Proposing Release, the independence of the units would be evidenced by a variety of factors, such as separate management structures, location, business purpose, and profit and loss treatment.
26 Two commenters focused on expanding aggregation unit netting to non-broker-dealers. See letters from LEK Securities; MFA. The Commission has determined not to extend aggregation unit netting to entities that lack self-regulatory oversight and are not subject to Commission examination. The lack of regulatory oversight may facilitate the creation of units that are not truly independent or separate.
27 As with any rule, broker-dealers relying on this exception should be prepared to monitor for compliance with its conditions, and maintain records documenting such compliance.
28 Securities Exchange Act Release No. 15533 1979 (January 29, 1979), 44 FR 6084 (January 31, 1979) (noting that the Commission has long recognized the important role that block positioning plays in providing liquidity for large securities transactions and in maintaining fair and orderly markets).
29 See Securities Exchange Act Release No. 20230 (September 27, 1983) 48 FR 45119 (October 3, 1983)(proposing the block positioner exception); see also Securities Exchange Act Release No. 20715 (March 6, 1984), 49 FR 9414 (March 13, 1984) (adopting the block positioner exception).
30 "Standardized options contract" is defined in Rule 9b-1(a)(4) under the Exchange Act. 17 CFR 240.9b-1(a)(4).
31 The Commission proposed to codify this relief in 1992, but the proposal was not adopted.
See Securities Exchange Act Release No. 30772 (June 3, 1992), 57 FR 24415 (June 9, 1992).
32 See letter re: Merrill Lynch, Pierce, Fenner & Smith, Inc. (December 17, 1986); Securities Exchange Act Release No. 27938 (April 23, 1990), 55 FR 17949 (April 30, 1990) (clarifying and emphasizing certain aspects of the limited relief granted in the Merrill Lynch letter). The Merrill Lynch letter provided no-action relief if: (i) the firm has a long stock position as part of an index arbitrage position; (ii) the stock is being sold in the course of "unwinding" an index arbitrage position; and (iii) the sale would be a short sale, as defined in Rule 3b-3, solely as a result of the netting of the index arbitrage long position with one or more short positions created in the course of bona-fide hedge activities.
33 See letters from LEK Securities; Willkie Farr & Gallagher, LLP ("Willkie Farr") (sent on behalf of J.P. Morgan Securities and UBS Securities).
34 We have adopted language that closely resembles the block positioner exception in Rule 200(d) since we believe that the economic rationale for and the operation of both exceptions are analogous. Securities Exchange Act Release No. 30772 (June 3, 1992), 57 FR 24415 (June 9, 1992) at n. 60 (citing Securities Exchange Act Release No. 20230, 48 FR at 45119); Securities Exchange Act Release No. 20715 (March 6, 1984), 49 FR 9414 (March 13, 1984)).
35 17 CFR 240.10a-1(d).
36 In this situation, the seller may be entitled to rely on an exception if the seller "owns the security sold and intends to deliver such security as soon as possible without undue inconvenience or expense." 17 CFR 240.10a-1(e)(1). Additionally, the seller may be entitled to rely on an exception from Rule 203(b)(2)(ii), as adopted, if the seller owns the security sold pursuant to Rule 200, and the seller intends to deliver the security as soon as all restrictions on delivery have been removed, and no later than 35 days after trade date. See Rule 203(b)(2)(ii), discussed further in Part V.A.1.c., infra. However, without an exception to the price test, this sale should be marked "short."
37 See Proposing Release, Section V.
38 See letters from James Angel; Archipelago Holdings ("ARCA"); Yuseff J. Burgess; Chicago Board Options Exchange ("CBOE"); Dario Cosic; Davis Polk; Timothy K. Dolnier; Tolga Erman; Chris Freddo; Kristopher Goldhair; Chris Gregg; Marc Griffin; Charles W. Hansford; Zachary Hepner; ICI; Mike Ianni; Brian Ingram; Kevin Karlberg; Gregory Kleiman; LEK Securities; Michael Lucarello; Hal Lux and Leon M. Metzger; Managed Funds Association ("MFA"); Raymond J. Murphy; Nasdaq Stock Market ("Nasdaq"); Osmar92@optonline.net; Tal Plotkin; David Schwarz; Sinan Selcuk; Theodore J. Siegel; Todd Sherman; SIA; Dan Solomon; The Securities Traders Association ("STA"); Securities Traders Association of New York ("STANY"); Jimmie E. Williams; Willkie Farr.
39 See, e.g., letters from Anthony Gentile; Robert Morrow; NYSE; The Specialists Association. The NYSE asserted that a pilot will create a confusing system that will "slow trading, lead to errors and baffle market participants" as well as create "artificially anomalous price situations, particularly for securities within the same industry where some are subject to a `tick' or `bid' test and others are not."
40 Some commenters suggested expanding the scope of stocks that may be included in a pilot. See letters from CBOE; Coreina Chan; Timothy K. Dolnier; Charles W. Hansford; Zachary Hepner; Gregory Kleiman; Michael Lucarello; Nasdaq; Osmar92@optonline.net; Tal Plotkin; David Schwarz; Dan Solomon; STA; STANY; Hiro Shinohara; Daniel C. Sweeney. Additionally, some advocated including less liquid Nasdaq NMS and listed securities, while others argued for including groups of stocks with the two highest position limit tiers for listed options. See letters from STA; STANY; CBOE. SIA's letter suggested using stocks that currently qualify for the Regulation M exception for actively-traded securities because they are less susceptible to market manipulation and because programming costs may be less as many broker-dealers already have systems in place to identify such stocks.
41 See letters from James Angel; Charles Schwab Capital Markets ("Charles Schwab"); Nasdaq; NYSE; STA; STANY.
42 The Commission may in the future issue other orders adopting other pilot programs.
43 See, e.g., letter from SONECON, LLC.
44 No individual issuers submitted comment letters opposing a pilot or expressing concern about the possible disparate trading of securities subject to a pilot or about the possible adverse impact on their securities should the price test be removed from short selling in their stock on a temporary basis. However, the NYSE submitted a letter expressing concern "on behalf of its members and its listed companies" that strongly supported continuing price restrictions and expressed concern about unscrupulous market participants forcing prices lower in stocks not subject to a price test.
45 See, e.g., Securities Act of 1933 ("Securities Act") Section 17(a), and Exchange Act Sections 9(a), 10(b), and 15(c) and Rules 10b-5 and 15c1-2 thereunder.
46 Also, the order permits the Commission to act quickly to modify the pilot to address any adverse results, should we determine that continued operation of an established pilot would not be necessary or appropriate in the public interest or inconsistent with the protection of investors.
47 The NYSE asserted that it should be allowed to maintain a tick test for short sales on the NYSE even if the Commission determines to eliminate price restrictions on short sales. The Specialist Association also argued for maintaining the current tick test on exchange-listed securities.
48 Proposing Release, Section XIV.A. After the consolidated tape ceases to operate, the tick test rule prevents any person from effecting a short sale at a price that is lower than the last sale reported to the tape.
49 See, e.g., letters from James Angel; Charles Schwab; Davis Polk; Goldman; Citigroup; Merrill Lynch; Morgan Stanley; LEK Securities; MFA; SIA; Susquehanna International Group, LLP; Willkie Farr.
50 See, e.g., letters from Goldman, Citigroup, Merrill Lynch, Morgan Stanley.
51 See, e.g., letter from SIA.
52 The order that is being issued concurrently with this release includes a pilot for short sales occurring after hours. See, n. 7, supra.
53 Most commenters welcomed the Commission's proposal as a means to address potential manipulation through so called "naked" short selling, and additionally welcomed replacing the current disparate SRO requirements with a uniform Commission rule. See, e.g., letters from NYSE; Nasdaq; SIA.
54 Any broker-dealer using the United States jurisdictional means to effect short sales in securities traded in the United States would be subject to Regulation SHO, regardless of whether the broker-dealer is registered with the Commission or relying on an exemption from registration. In addition, Commission staff members have engaged in discussions with staff of The Investment Dealers Association of Canada ("IDA"), who have confirmed that the IDA intends to issue an interpretation that failure of IDA members to comply with the requirements of Regulation SHO may be considered a breach of IDA rules. This would be consistent with an interpretation that the IDA recently issued regarding an amendment to NASD Rule 3370, noting that IDA members would be required to make an affirmative determination that the member will receive delivery of the security from its customer or that the member can borrow the security on behalf of the customer by settlement date. It was stated that failure of IDA members to make such an affirmative determination may be considered a breach of IDA rules. Investment Dealers Association of Canada Member Regulation Notice MR0282 (April 13, 2004). The NASD amendment had extended the affirmative determination requirements to short sale orders that NASD members receive from non-member broker-dealers. Securities Exchange Act Release No. 48788 (November 14, 2003), 68 FR 65978 (November 24, 2003); NASD Notice to Members 04-03 (January, 2004); NASD Notice to Members 04-21.
55 This is consistent with the current practice under NASD Rule 3370. See, e.g., Ko Securities, Inc. and Terrance Y. Yoshikawa, Securities Exchange Act Release No. 48550 (September 26, 2003) (holding that an affirmative determination, i.e., a "locate," must be made before the securities are sold short regardless of whether the short seller repurchases securities on the same day).
56 Several commenters addressed on this issue. See, e.g., letters from NYSE; SIA.
57 See, e.g., letter from NYSE.
58 A broker-dealer may obtain an assurance from a customer that such party can obtain securities from another identified source in time to settle the trade. This may provide the "reasonable grounds" required by Rule 203(b)(1)(ii). However, where a broker-dealer knows or has reason to know that a customer's prior assurances resulted in failures to deliver, assurances from such customer would not provide the "reasonable grounds" required by 203(b)(1)(ii). The documentation required by Rule 203(b)(1)(iii) should include the source of securities cited by the customer. The broker-dealer also should be able to demonstrate that there are "reasonable grounds" to rely on the customer's assurances, e.g., through documentation showing that previous borrowings arranged by the customer resulted in timely deliveries in settlement of the customer's transactions.
59 According to the current NASD "affirmative determination" rule, the manner by which a member or person associated with a member annotates compliance with the affirmative determination requirement is to be decided by each member. Members may rely on "blanket" or standing assurances (i.e., "Easy to Borrow" lists) that securities will be available for borrowing on settlement date. For short sales executed in Nasdaq National Market ("NNM") or exchange-listed securities, members also may rely on "Hard to Borrow" lists indentifying NNM or listed securities that are difficult to borrow or unavailable for borrowing on settlement date provided that: (i) any securities restricted pursuant to NASD Rule 11830 must be included on such a list; and (ii) the creator of the list attests in writing (on the document or otherwise) that any NNM or listed securities not included on the list are easy to borrow or are available for borrowing. Members are permitted to use Easy to Borrow or Hard to Borrow lists provided that: (i) the information used to generate the list, is no more than 24 hours old; and (ii) the member delivers the security on settlement date. Should a member relying on an Easy to Borrow or Hard to Borrow list fail to deliver the security on settlement date, the NASD deems such conduct inconsistent with the terms of Rule 3370, absent mitigating circumstances adequately documented by the member. See NASD Rule 3370(b)(4)(C).
60 In its comment letter, the SIA noted that in developing "Easy to Borrow" lists, broker-dealer stock loan desks use information from a number of sources, including institutional lenders that have sophisticated systems for estimating borrow supply. Broker-dealer stock loan desks also consider the availability of inventory at their own firms and potential availability from other broker-dealers that act as conduit lenders. Much of this information is available through electronic feeds and is updated frequently. See letter from SIA.
61 A broker-dealer could look to a lender's statement to the broker-dealer regarding the amount of securities available to lend on an "Easy to Borrow" list.
62 Of course, securities that are "threshold securities" pursuant to Rule 203(c) should generally not be included on "Easy to Borrow" lists.
63 See, e.g., letter from NYSE. In particular, the NYSE stated that, "We believe that the use of `easy to borrow' lists, together with an industry-wide list of securities where there is evidence of significant settlement failures (i.e., those for which there are fails to deliver at a clearing agency of 10,000 shares or more and that is equal to at least one-half of one percent of the issue's total shares outstanding) prepared daily by the National Securities Clearing Corporation ("NSCC") as proposed, would be a more appropriate means of determining whether a security sold short could be borrowed. Consequently, the Exchange believes that broker-dealers should be required to make an affirmative determination for those securities that are not on the `easy to borrow' list."
64 This could include an electronic communications network (ECN).
65 Of course, an executing broker-dealer who executes a short sale pursuant to an order from an introducing broker as part of a scheme to manipulate the security, or where, for example, it knows that the introducing broker did not perform the locate, could be liable under the securities laws, for, among other violations, committing or aiding and abetting a violation of Rule 203(b)(1). See, e.g., Sections 15(b)(4)(e) and 20(e) of the Exchange Act. 15 U.S.C. 78t.
66 Section 3(a)(38) states: "The term `market maker' means any specialist permitted to act as a dealer, any dealer acting in the capacity of a block positioner, and any dealer who, with respect to a security, holds himself out (by entering quotations in an inter-dealer quotation system or otherwise) as being willing to buy and sell such security for his own account on a regular or continuous basis." 15 U.S.C. 78c(a)(38).
67 As noted in the Proposing Release, we believe that a narrow exception for market makers engaged in bona-fide market making activities is necessary because they may need to facilitate customer orders in a fast moving market without possible delays associated with complying with the "locate" requirement.
68 Moreover, a market maker that continually executed short sales away from its posted quotes would generally be unable to rely on the bona-fide market making exception.
69 See also NASD IM-3350(c)(2) ("A market maker would be deemed in violation of the Rule if it entered into an arrangement with a member or a customer whereby it used its exemption from the rule to sell short at the bid at successively lower prices, accumulating a short position, and subsequently offsetting those sales through a transaction at a prearranged price, for the purpose of avoiding compliance with the Rule, and with the understanding that the market maker would be guaranteed by the member or customer against losses on the trades."). Although the IM-3350 interpretation applies expressly to the bid test in NASD Rule 3350, the NASD previously found that the standards set forth are equally applicable to the market maker exemption in NASD Rule 3370. See NASD Hearing Panel Decision as to Respondents John Fiero and Fiero Brothers, Inc. (December 6, 2000); See also Section 20(b) of the Exchange Act, 15 U.S.C. 78t.
70 Pursuant to Rule 200(g), a broker or dealer shall mark an order to sell a security "long" only if the seller is deemed to own the security being sold pursuant to 17 CFR 242.200 and either: (i) the security to be delivered is in the physical possession or control of the broker or dealer; or (ii) it is reasonably expected that the security will be in the physical possession or control of the broker or dealer no later than the settlement of the transaction. See, supra Part III.B. for a further discussion of the order marking requirements.
71 Another situation could be where a customer owns stock that was formerly restricted, but pursuant to Rule 144 under the Securities Act of 1933, the securities may be sold without restriction. In connection with a sale of such security, the security may not be capable of being delivered on settlement date, due to processing to remove the restricted legend. See, e.g., letter from Feldman Weinstein, LLP ("Feldman").
72 We believe that 35 days is a reasonable outer limit to allow for restrictions on a security to be removed if ownership is certain. We note that Section 220.8(b)(2) of Regulation T of the Federal Reserve Board allows 35 days to pay for securities delivered against payment if the delivery delay is due to the mechanics of the transaction. 12 CFR 220.8(b)(2).
73 See NASD Rule 3370(b)(2)(B), which states in pertinent part that, "[n]o member shall effect a `short' sale for its own account in any security unless the member or person associated with a member makes an affirmative determination that the member can borrow the securities or otherwise provide for delivery of the securities by settlement date. This requirement will not apply to...transactions that result in fully hedged or arbitraged positions." Rule 3370(b) provides guidelines in determining the availability of the exception.
74 See first and fourth letters from Saul Ewing, LLP., on behalf of Greenwood Partners. The commenter noted the situation where a market participant views the issuer's warrants as being overly rich in comparison to the pricing of the warrants, and will thus sell the underlying stock short and purchase the warrants. It also stated that, because the stock borrow programs for many smaller issuers are virtually non-existent, the market participant engaging in this activity may be required to sell short naked. In order to guard against potential "death spiral" activity, it was requested that the exception be limited to warrants with a fixed price per share conversion ratio.
75 See third letter from Saul Ewing, LLP. Specifically, the commenter, writing on behalf of an unnamed private equity fund, argued that the fund provides financing to smaller issuers, with a typical transaction generally involving a private placement of restricted stock in a company at a fixed price in exchange for an agreement to provide cash for such shares upon the closing of the transaction. In order to hedge the risk of market price changes in the restricted shares, the fund would buy over-the-counter put options from a counterparty. It was argued, however, that the counterparty would want to hedge its risk by purchasing an in-the-money call option, and shorting the underlying stock. It was similarly argued that due to the dearth of borrowable shares in some smaller issuers, the sales could be naked short sales.
76 In a recent matter, the Commission accepted offers of settlement from Rhino Advisors and Thomas Badian, Rhino's president, in connection with trading in the common stock of Sedona Corporation by Rhino on behalf of certain foreign entities. The Commission alleged that Rhino and Badian, acting in their capacities as investment advisors, manipulated Sedona's stock price downward by engaging in naked short selling of Sedona's stock in accounts maintained in the names of others. In the complaint filed in the action, the Commission alleged that Rhino manipulated Sedona's stock price to enhance an offshore entity's economic interests in a $3 million convertible debenture issued by Sedona and that, by depressing Sedona's stock price, Rhino increased the number of shares that the offshore entity received when it exercised its conversion rights under the debenture. See Rhino Advisors, Inc. and Thomas Badian, Litigation Release No. 18003 (February 27, 2003); see also SEC v. Rhino Advisors, Inc. and Thomas Badian, Civ. Action No. 03 Civ 1310 (SDNY March 5, 2003).
77 See Section 203(d) of Regulation SHO, 17 CFR 242.203(d), and Section 36 of the Exchange Act. 15 U.S.C. 78mm.
78 Two commenters requested an exception to the locate and delivery requirements for ETFs. The commenters maintain that ETFs should not be subject to the requirements of Rule 203 because ETFs have the ability to continuously create and redeem shares. See letters from Amex; Nasdaq.
79 Prior exemptions from Rule 10a-1 have been granted for transactions in certain ETFs. See, e.g., Letter re: SPDRs (January 27, 1993); Letter re: MidCap SPDRs (April 21, 1995); Letter re: Select Sector SPDRs (December 14, 1998); Letter re: Units of the Nasdaq-100 Trust (March 3, 1999); Letter re: ETFs (August 17, 2001) (class letter).
80 "Participant" is defined in Section 3(a)(24) of the Exchange Act. 15 U.S.C. 78c(a)(24). A "registered clearing agency" is a clearing agency, as defined in Section 3(a)(23)(A) of the Exchange Act, (15 U.S.C. 78c(a)(23)(A)), that is registered with the Commission pursuant to Section 17A of the Exchange Act, 15 U.S.C. 78q-1.
81 Rule 203(c)(5) defines "settlement day" to mean any business day on which deliveries of securities and payments of money may be made through the facilities of a registered clearing agency.
82 As proposed, the restrictions of Rule 203 would have covered equity securities registered under Section 12 of the Exchange Act. We are also extending the delivery restrictions to equity securities of issuers subject to Exchange Act reporting pursuant to Section 15(d). This would thus mandate coverage of those companies that are required to provide ongoing public disclosure about the company, its actions, and its performance. As the calculation of the threshold that would trigger the delivery requirements of Rule 203 depends on identifying the aggregate fails to deliver as a percentage of the issuer's total shares outstanding, it is necessary to limit the requirement to companies that are subject to the reporting requirements of the Exchange Act.
83 For example, if an issuer had 1,000,000 shares outstanding, one-half of one percent (.005) would be 5,000 shares. An aggregate fail to deliver position at a clearing agency of 10,000 shares or more would thus exceed the specified level of fails. If an issuer had 10,000,000 shares outstanding, one-half of one percent would be 50,000 shares. An aggregate fail to deliver position at a clearing agency of 50,000 shares or greater would exceed the specified level of fails.
84 We are incorporating the same threshold that is currently used in NASD Rule 11830. Because of this, it is our belief that implementation will not impose excessive programming costs on the industry, although we note that some programming modifications will be necessary to extend the current calculation beyond the current universe of Nasdaq securities.
85 As noted by some commenters, there may be many different causes of fails to deliver that could be unrelated to a market participant engaging in naked short selling. Thus, imposing a lower threshold or, as suggested by some commenters, prohibiting all fails, might be impracticable or an overly-broad method of addressing any potential abuses, and could also disrupt the efficient functioning of the Continuous Net Settlement system ("CNS") operated by the National Securities Clearing Corporation ("NSCC"). For example, one commenter noted that some fails are caused by custodian banks failing to deliver on behalf of their customers for a number of reasons, such as where a foreign domiciled customer engages in arbitrage involving American Depositary Receipts ("ADRs") and operates under the international arbitrage exemption provided in Rule 10a-1(e)(8). See letter from LEK Securities.
Additionally, some commenters addressed NSCC's securities lending program. See, e.g., letter from NASAA at 3. In responding to comments on the stock borrow program, NSCC noted that the program can reduce fails and give purchasers an increased chance of receiving those securities on settlement date. See letter from NSCC at 6-7. The Commission notes that NSCC's stock borrow program, as approved by the Commission, permits NSCC to borrow securities for the purpose of completing settlements only if participants have made those securities available to NSCC for this purpose and those securities are on deposit in the participant's account at The Depository Trust Company ("DTC"). See Securities Exchange Act Release No. 17422 (December 29, 1980), 46 FR 3104 (January 13, 1981).
86 Some stocks that are quoted in the Pink Sheets are not reporting issuers, and thus there is not a readily available means to determine the total shares outstanding in such securities. If, however, we incorporate non-reporting issuers that have aggregate fails in excess of 10,000 shares, only an additional 1% of all securities would be added. These securities will not be subject to the additional requirements imposed upon threshold securities, although broker-dealers effecting short sales in these securities are subject to the locate requirements of Rule 203(b)(1).
87 For example, an issuer that had 10,000,000 shares outstanding and an aggregate fail to deliver position greater than 50,000 shares for at least five consecutive settlement days, would be a threshold security, and would no longer be a threshold security after the aggregate fail to deliver position was less than 50,000 shares for at least five consecutive settlement days.
88 For example, we note the situation involving ADR arbitrage as described in n. 84, supra.
89 A person that sells a security and fails to deliver, with the intent of triggering the close-out requirement of Rule 203(b)(3) and creating a short squeeze that could benefit a person's long position, could be deemed to be engaging in manipulative behavior.
90 It is expected that the NYSE will calculate and disseminate a list of NYSE-listed securities that exceed the specified fails level for at least five consecutive settlement days. Amex will calculate and disseminate a list of Amex-listed securities that exceed the specified fails level for at least five consecutive settlement days, in addition, the NASD will calculate and disseminate a list of all over-the-counter securities, including Nasdaq, OTCBB, and Pink Sheet securities that exceed the specified fails level for at least five consecutive settlement days. It is expected that the lists of threshold securities will be disseminated prior to the commencement of each trading day.
91 As NSCC noted in its comment letter, it is providing the Commission, the NYSE, the NASD, and Amex with a daily report listing information on all participant short obligations for all equity securities with aggregate clearing short positions greater than 10,000 shares. The SROs will calculate whether the aggregate fails at NSCC exceed 0.5% of the issuer's total shares outstanding.
92 See, e.g., letter from SIA. The SIA, as well as several other commenters, stated the belief that buy-ins were more practical since it is possible to allocate the costs of a buy-in among multiple short sellers, whereas application of the proposed account trading restriction is not feasible. Other commenters stated that the fear of a mandatory buy-in and threat of a market loss would be a greater deterrent than the proposed restriction and withholding of the mark. See, e.g., letter from H. Glenn Bagwell, Jr.
93 We note that some commenters believed that imposing the delivery requirements two days after settlement, i.e., after five settlement days, would capture many instances of ordinary course settlement delays, rather than address potentially abusive activity. See, e.g., letters from CBOE; SIA; Willkie Farr. OEA took a snapshot of fails data received from NSCC from April 19 through April 30, 2004, which confirmed a rate of decline over a course of settlement days. Similar rates of decline were found using data obtained from NSCC for other periods during the past six months. In addition, because Rule 203(b)(3) would require a participant to close out all fails to deliver in threshold securities, whether resulting from short sales or long sales, extending the time period to ten days after settlement would make the close-out requirement consistent with 17 CFR 240.15c-3-3(m). Ten days after settlement is also the timeframe currently identified in NASD Rule 11830.
94 A participant of a registered clearing agency includes registered broker-dealers, and entities that may not be registered broker-dealers, but are responsible for the settlement of transactions at a registered clearing agency, such as the Canadian Depository for Securities ("CDS").
95 The following examples illustrate potential scenarios involving threshold security XYZ: (i) If a participant has a 100 share fail to deliver position in XYZ for 13 consecutive settlement days, the participant is required to purchase 100 shares; (ii) If a participant has a 100 share fail to deliver position in XYZ, and the fail to deliver position increases by 100 shares each day for 13 consecutive settlement days, yielding a 1300 share fail to deliver position, then the participant is required to purchase 100 shares at the end of the 13th day, 100 shares the next day, etc., until the entire fail to deliver position is closed out; (iii) If a participant has a 100 share fail to deliver position in XYZ, which is then reduced to a 50 share fail to deliver position during the following 13 consecutive settlement days, then the participant is required to close out 50 shares; or (iv) If a participant has a 100 share fail to deliver position in XYZ, which is netted to zero five settlement days later, and then a new 100 share position is established the following day, the participant would not be required to close out the initial 100 shares, but would be required to close out the subsequent 100 share fail to deliver position if it remained for 13 consecutive settlement days.
96 This includes the situation where a broker-dealer that was required to close out a fail to deliver in a security exceeding the threshold entered into an arrangement to buy from a counterparty, and thus net out the broker-dealer's position at CNS, but the broker-dealer knew or had reason to know that the counterparty did not intend to deliver the security, which thus created another fail in the CNS system.
97 Rule 203(b)(3)(i). This is consistent with the current operation of NASD Rule 11830.
98 For example, if a participant had a 100 share fail to deliver position in XYZ security prior to XYZ becoming a threshold security, and if XYZ subsequently became a threshold security, the participant would not be required to close out the 100 share fail, even if it remained for 13 consecutive settlement days. Therefore, if after becoming a threshold security the fail to deliver position in XYZ increased to 200 shares, and remained for 13 consecutive settlement days, the participant would be required to close out 100 shares. If, after becoming a threshold security, the participant's total fail to deliver position in XYZ fell to 50 shares, and then rose to 150 shares and remained for 13 consecutive settlement days, the participant would be required to close out 100 shares, rather than only 50 shares.
99 See letter from NSCC at p. 5 for further discussion regarding the operation of the CNS system.
100 See, e.g., letters from Knight; Susquehanna; Pacific Exchange ("PCX"); Amex; joint letter from Amex; CBOE; International Securities Exchange ("ISE"); The Options Clearing Corporation ("OCC"); PCX; Philadelphia Stock Exchange ("PHLX") ("Joint Options Letter").
101 See Joint Options Letter.
102 See letter from Susquehanna. In particular, this commenter believed that market makers would need to assess for each assigned security the probability that it would become a threshold security at some point in the future, and in circumstances in which this is thought to be a realistic possibility, the market maker would need to decide whether to incorporate the added risks into pricing or relinquish market maker status in the particular security.
103 See Rule 203(b)(3)(i).
104 OEA has estimated that approximately 4.1% of all securities that have options traded on them would meet the threshold.
105 See Joint Options Letter.
106 See letter from SIA (which noted in pertinent part, "[t]he SEC and SROs may also want to consider whether to utilize their existing authority to determine to what extent non-bona-fide market making trading activities by market makers does or does not contribute to extended fails."); see also Evans, Geczy, Musto & Reed, Failure is an Option: Impediments to Short Selling and Options Prices, Working Paper, The Wharton School at the University of Pennsylvania and the University of North Carolina (March 1, 2003) (finding that the options market maker exemption from the requirement to locate stock to borrow on short sales may create significant profits for the market makers).
107 See letters from H. Glenn Bagwell, Jr.; Feldman; LEK Securities.
108 See letter from Feldman. We have addressed this situation by providing an exception in Rule 203(b)(2)(ii) for situations where a broker effects a sale on behalf of a customer that is deemed to own the security pursuant to Rule 200, although, through no fault of the customer or the broker-dealer, it is not reasonably expected that the security will be in the physical possession or control of the broker-dealer by settlement date, and is thus a "short" sale under the marking requirements of Rule 200(g) as adopted.
109 See Letter Type A; SIA. The Commission disagrees with these comments. We believe that the provisions of Rule 203(a) are appropriate to guard against fails to deliver on long sales, in that a broker may fail to deliver borrowed shares on long sale fails only in the limited circumstances set forth in the rule. In addition, Rule 203(b)(3) requires a participant to close out all fails to deliver that remain in threshold securities for 13 consecutive settlement days. 17 CFR 240.15c-3-3(m) also addresses fails to deliver on long sales.
110 See Rule 203(a)(2)(ii).
111 It may be unreasonable for a broker-dealer to treat a sale as long where orders marked "long" from the same customer repeatedly require borrowed shares for delivery or result in "fails to deliver." A broker-dealer also may not treat a sale as long if the broker-dealer knows or has reason to know that the customer borrowed the shares being sold.
112 As with other provisions of Regulation SHO, this provision requires good faith conduct by the broker-dealer. Therefore, where the broker-dealer did not in good faith believe that the customer would deliver the securities in time for settlement, the broker-dealer cannot borrow or lend securities to deliver when the customer fails.
113 See, supra part III.B. for a discussion of the order marking requirements.
114 17 CFR 242.105.
115 As noted in the Proposing Release, Rule 105 of Regulation M applies to offerings of securities for cash pursuant to a registration statement or a notification on Form 1-A filed under the Securities Act.
116 A "follow-on offering" is an issuance of additional securities by an issuer that is subject to the reporting requirements pursuant to Sections 13 or 15(d) of the Exchange Act. 15 U.S.C. 78m, 78o(d).
117 See Proposing Release, Section XVI.
118 See Anti-manipulation Rules Concerning Securities Offerings; Final Rule, Securities Exchange Act Release No. 38067, 62 FR 520, 538 (January 3, 1997) ("Regulation M Release"), where the Commission stated "it may be necessary for the Commission to reevaluate this exclusion if the availability of shelf registration is further expanded or offerings of shelf-registered equity become more common-place."
119 See Short Sales in Connection with a Public Offering, Securities Exchange Act Release No. 26028, 53 FR 33455, 33458 (August 25, 1988) ("Rule 10b-21(T) Release"), adopting Rule 10b-21(T).
120 See letters from The Bond Market Association ("TBMA"); Feldman; SIA.
121 See letter from Feldman, at 5.
122 See letter from SIA.
123 One commenter asked the Commission to consider excluding non-equity securities offerings from the scope of Rule 105, claiming that the type of manipulative activity with which Rule 105 is concerned is less likely to occur in debt offerings than in equity offerings. See TBMA letter. We continue to believe that bond offerings present a potential for manipulation, and we have therefore determined that non-equity offerings will continue to be subject to the prohibitions of Rule 105. The Commission will consider granting exemptive relief on a case-by-case basis where warranted.
124 The Commission has previously stated its concern with transactions where an intermediary is used to purchase covering shares from the offering. See Rule 10b-21(T) Release, 53 FR at 33460.
125 See also Exchange Act Section 20(b), 15 U.S.C. 78t.
126 See also Exchange Act Section 9(a )(1), 15 U.S.C. 78i(a)(1). For example, an individual places limit orders to sell and buy the same amount of shares, and the transaction is crossed in the individual's brokerage account. There is no change in beneficial ownership and no market risk associated with the transaction, i.e., these are "wash sales." Although the individual has attempted to disguise the fact that the offering shares are being used to cover the short sale, in fact, he is covering his pre-pricing short sale with shares obtained in the offering. See, e.g., Ascend Capital, LLC, Securities Exchange Act Release No. 48188 (July 17, 2003).
127 15 U.S.C. 78i(a), 78j(b).
128 44 U.S.C. 3501.
129 NASD Rule 3370(b)(4)(B).
130 This number is based on 2003 FOCUS Report filings reflecting registered broker-dealers. This number does not include broker-dealers that are delinquent on FOCUS Report filings.
131 In calendar year 2003, there were approximately 722,753,000 trades on the NYSE, 733,410,000 on Nasdaq NMS and Nasdaq SmallCap, and over 9,400,860 in OTCBB, Pink Sheet, and other (gray market) securities.
132 For Nasdaq NMS and Nasdaq SmallCap securities.
133 As stated in the Proposing Release, we believe it is reasonable that it would take 0.5 seconds (or .000139 hours) to mark an order "long," "short," or "short exempt."
134 See Guidance Release, at n. 17, supra.
135 Firms that find difficulty in complying with the aggregation unit netting conditions in Rule 200(f) may submit requests for exemptive relief.
136 As provided in the Merrill Lynch Letter. See Securities Exchange Act Release No. 27938, n. 31 supra..
137 For Rule 200(e)(3) relief, the sale does not occur during a period commencing at the time that the Dow Jones Industrial Average ("DJIA") has declined below its closing value on the previous trading day by at least two percent and terminating upon the establishment of the closing value of the DJIA on the next succeeding trading day during which the DJIA has not declined by two percent or more from its closing value on the previous day.
138 Securities Exchange Act Release No. 41041 (February 11, 1999) 64 FR 8424 (February 19, 1999)(approval of amendments to NYSE Rule 80A). We note that NYSE 80A removes the stabilizing requirement if the DJIA moves within 2% of the previous day's close.
139 Short sellers would have to aggregate in the usual way, with all of the seller's other positions in that security, to determine whether the seller has a net long position.
140 This is an average of approximately 223,647 annual responses by each respondent. Each response of marking orders "long," "short," or "short exempt" takes approximately .000139 hours (.5 seconds) to complete. Thus, the total approximate estimated annual hour burden per year is 203,713 burden hours (1,465,563,860 responses at 0.000139 hours per response). A reasonable estimate for the paperwork compliance for the proposed rules for each broker-dealer is approximately 31 burden hours (223,647 responses at .000139 hours per response) or a total of 203,713 burden hours between 6,553 respondents.
141 See letters from James Angel; ARCA; Yuseff J. Burgess; CBOE; Dario Cosic; Davis Polk; Timothy K. Dolnier; Tolga Erman; Chris Freddo; Kristopher Goldhair; Chris Gregg; Marc Griffin; Charles W. Hansford; Zachary Hepner; ICI; Mike Ianni; Brian Ingram; Kevin Karlberg; Gregory Kleiman; LEK Securities; Michael Lucarello; Lux & Metzger; MFA; Raymond J. Murphy; Nasdaq; Osmar92@optonline.net; Tal Plotkin; David Schwarz; Sinan Selcuk; Theodore J. Siegel; Todd Sherman; SIA; Dan Solomon; STA; STANY; Jimmie E. Williams; Willkie Farr.
142 See NASD Head Trader Alert #2000-55 (August 7, 2000).
143 No individual issuers submitted comment letters opposing the pilot or expressing concern about the possible disparate trading of securities subject to the pilot or about the possible adverse impact on their securities should the price test be removed from short selling in their stock on a temporary basis. The NYSE submitted a letter expressing concern, "on behalf of its members and its listed companies" strongly supporting continued price restrictions and expressing concern about
144 See, e.g., Securities Act Section 17(a), and Exchange Act Sections 9(a), 10(b), and 15(c) and Rules 10b-5 and 15c1-2 thereunder.
145 The Commission approved a rule change filed by DTC that clarified that DTC's rules permit only its participants to withdraw securities from the depository. See Securities Exchange Act Release No. 47978 (June 4, 2003), 68 FR 35037 (June 11, 2003). In addition, the Commission recently proposed a rule, "Issuer Restrictions or Prohibitions on Ownership by Securities Intermediaries," which would prohibit a registered transfer agent from transferring any equity security registered pursuant to Section 12 of the Exchange Act, or any equity security that subjects an issuer to reporting under Section 15(d) of the Exchange Act, if such security is subject to any restriction or prohibition on transfer to or from a securities intermediary. See Securities Exchange Release No. 49804 (June 4, 2004), 69 FR 32783 (June 10, 2004).
146 See, e.g., SEC vs. Universal Express, Inc., et. al., Litigation Release No. 18636 (March 24, 2004). Securities Exchange Act Release No. 49566 (April 15, 2004).
147 Securities Exchange Act Release No. 49566 (April 15, 2004). The proposal would prohibit the use of Form S-8, under the Securities Act, by a shell company. In addition, the release proposes amendments to Form 8-K, under the Exchange Act, to require a shell company, when reporting an event that causes it to cease being a shell company, to file with the Commission the same type of information that it would be required to file to register a class of securities under the Exchange Act. The provisions in this release target regulatory problems that the Commission has identified where shell companies have been used as vehicles to commit fraud and abuse the regulatory processes.
148 The general locate requirement for short sales will not impose additional costs on broker-dealers, since current SRO rules require broker-dealers to effect such a locate.
149 Industry participants appeared more concerned with having enough time to make the necessary programming and systems upgrades than the actual costs related to such upgrades.
150 We have decided at this time not to extend to market makers an exception from the additional requirements to close out fails to deliver in securities exceeding the threshold that remain ten days after settlement date.
151 OEA has also estimated that approximately 4% of all securities that have options traded on them would be threshold securities.
152 Industry participants could not produce a quantifiable estimate for the cost related to the "borrow or arrange to borrow" requirement for failing to close-out deliveries in threshold securities that remain open for ten days past the settlement date. Additionally, some industry participants provided inconsistent statements regarding the amount of securities for which a locate is given, compared to whether a short sale execution actually occurs. The estimated range is anywhere from 10% to 80%.
153 As in former Rule 10a-2, these prohibitions do not apply to the loan of a security that occurs by way of a loan to another broker or dealer, or where an exchange or securities association finds, prior to the loan or fail, that the sale resulted from a good faith mistake, the broker-dealer exercised due diligence, and either that requiring a buy-in would result in undue hardship or that the sale had been effected at a permissible price.
154 Potential investors generally were not aware of a takedown until immediately prior to its occurrence, and thus their pre-pricing short sales were arguably non-manipulative.
155 15 U.S.C. 78c(f).
156 15 U.S.C. 78w(a)(2).
157 Pub. L. No. 104-121, tit. II, 110 Stat. 857 (1996).
158 See, e.g., Securities Act Section 17(a), and Exchange Act Sections 9(a), 10(b), and 15(c) and Rules 10b-5 and 15c1-2 thereunder.
159 5 U.S.C. 603.
160 See Proposing Release, Section XXII.
161 For example, one commenter expressed concern about the Commission's proposal for firms to aggregate their positions in securities on a contemporaneous basis throughout the day. The commenter claimed such a requirement would require system changes for those broker-dealers who have not implemented the aggregation units, i.e., smaller broker-dealers, and would be significantly expensive without the attenuating benefits. See letter from SIA. Also, other commenters were concerned about the impact of Regulation SHO on small issuers, claiming it would increase the cost of capital to them by imposing locate and delivery requirements in the absence of a hedging exemption. See letters from Saul Ewing and Feldman.
162 17 CFR 240.0-10(c)(1).
163 We believe this cost should be minimal because some self-regulatory organizations already either require or advise members to utilize the "short exempt" designation.
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Modified: 08/02/2004
Responses to Frequently Asked Questions Concerning Regulation SHO
Responses to these frequently asked questions were prepared by and represent the views of the staff of the Division of Market Regulation (“Staff”). They are not rules, regulations, or statements of the Securities and Exchange Commission (“Commission”). Further, the Commission has neither approved nor disapproved these interpretive answers.
For Further Information Contact: Any of the following attorneys in the Office of Trading Practices, Division of Market Regulation, Securities and Exchange Commission, 100 F Street, N. E., Washington, D.C. 20549-1001, at (202) 551-5720: James Brigagliano, Assistant Director, Josephine Tao, Branch Chief, Joan Collopy, Lillian Hagen, Elizabeth Sandoe, and Victoria Crane, Special Counsels.
I. Introduction
A short sale is the sale of a security that the seller does not own and any sale that is consummated by the delivery of a security borrowed by, or for the account of, the seller. In order to deliver the security to the purchaser, the short seller will borrow the security, typically from a broker-dealer or an institutional investor. The short seller later closes out the position by purchasing equivalent securities on the open market, or by using an equivalent security it already owned, and returning the borrowed security to the lender. In general, short selling is used to profit from an expected downward price movement, to provide liquidity in response to unanticipated demand, or to hedge the risk of a long position in the same security or in a related security.
Regulation SHO became effective on September 7, 2004. (Securities Exchange Act Release No. 50103 (July 28, 2004), 69 FR 48008 (August 6, 2004) (“Adopting Release”)). The commencement date to comply with the provisions of Regulation SHO is January 3, 2005. Pursuant to the terms of Regulation SHO, the Commission approved an order establishing a one-year pilot program (“Pilot”) suspending the provisions of Rule 10a-1(a) under the Securities Exchange Act of 1934 (“Exchange Act”) and any short sale price test of any exchange or national securities association (“SRO”) for short sales of certain securities for certain time periods. (See Securities Exchange Act Release No. 50104 (July 28, 2004), 69 FR 48032 (August 6, 2004) (“Pilot Order”)). The Adopting Release and the Pilot Order may also be found on the Commission’s Internet web site (http://www.sec.gov/spotlight/shortsales.htm). (See also http://www.sec.gov/rules/final/34-50103.htm for the Adopting Release, and http://www.sec.gov/rules/other/34-50104.htm for the Pilot Order). On November 29, 2004, the Commission approved an order resetting the Pilot to commence on May 2, 2005 and end on April 28, 2006. (See Securities Exchange Act Release No. 50747 (November 29, 2004), 69 FR 70480 (December 6, 2004) (“Second Pilot Order”)). The Second Pilot Order may be also be found on the Commission’s Internet web site (http://www.sec.gov/spotlight/shortsales.htm). (See also http://www.sec.gov/rules/other/34-50747.htm). Although the Second Pilot Order resets the start date and end date for the Pilot, the other terms of the Pilot Order remain unchanged, and the compliance date for all other provisions of Regulation SHO remains January 3, 2005. The Commission from time to time may approve further orders affecting the Pilot.
Regulation SHO provides a new regulatory framework governing short selling of securities. Regulation SHO is designed, in part, to fulfill several objectives, including (1) establish uniform locate and delivery requirements in order to address problems associated with failures to deliver, including potentially abusive “naked” short selling (i.e., selling short without having borrowed the securities to make delivery); (2) create uniform marking requirements for sales of all equity securities; and (3) establish a procedure to temporarily suspend Commission and SRO short sale price tests in order to evaluate the overall effectiveness and necessity of such restrictions. Moreover, the rules are consistent with the objective of simplifying and modernizing short sale regulation, providing controls where they are most needed, and temporarily removing restrictions where they may be unnecessary.
Specifically, Regulation SHO replaces Commission Rules 3b-3, 10a-1(d), 10a-1(e)(13) and 10a-2 with the following provisions:
* Rule 200 – Definitions and Marking Requirements. Rule 200 incorporates and amends Rules 3b-3, 10a-1(d) and 10a-1(e)(13). It defines ownership for short sale purposes, and clarifies the requirement to determine a short seller’s net aggregate position. It also incorporates requirements to mark sales in all equity securities “long,” “short,” or “short exempt.”
* Rule 202T – Pilot Program. Rule 202T is a temporary rule that creates a procedure by which the Commission issued the Pilot Order to establish the Pilot. It also creates a procedure by which the Commission may issue additional orders relating to the Pilot. This rule is scheduled to expire on August 6, 2007.
* Rule 203 – Locate and Delivery Requirements. Rule 203 incorporates Rule 10a-2 and existing SRO rules into a uniform Commission rule. It requires broker-dealers, prior to effecting short sales in all equity securities, to locate securities available for borrowing in order to be able to deliver securities on the settlement date of the transaction. It also imposes additional requirements on broker-dealers for securities in which a substantial amount of failures to deliver have occurred.
The Commission decided to defer consideration of proposed Rule 201, which would have replaced the current “tick” test of Rule 10a-1(a) with a new uniform bid test restricting short sales to a price above the consolidated best bid, subject to certain exceptions. (See Securities Exchange Act Release No. 48709 (October 28, 2003), 68 FR 62972 (November 6, 2003) (“Proposing Release”), which may also be found on the Commission’s Internet web site at http://www.sec.gov/rules/proposed/34-48709.htm). The Commission will reconsider any further action on these proposals after the completion of the Pilot.
Regulation SHO sets forth the requirements for conducting short sale transactions in equity securities. Other rules and regulations may apply also to short sales; for example, the margin requirements of Regulation T. Market participants conducting short sale transactions are responsible for complying with Regulation SHO as well as any other rules and regulations that may apply to their short sale transactions.
The following questions and answers regarding Regulation SHO have been compiled by the Staff to assist in the understanding and application of this regulation and the Pilot. These questions and answers are intended to provide general guidance. Facts and circumstances of a particular transaction may differ, and the Staff notes that even slight variations may require different responses. The Commission is not bound by the statements and may interpret Regulation SHO in any manner that it deems necessary or appropriate in the public interest or for the protection of investors.
The Staff may update these questions and answers periodically. In each update, the questions added after publication of the last version will be marked with “NEW!”
II. Responses to Frequently Asked Questions
1. General
Question 1.1: When should market participants comply with Regulation SHO?
Answer: Regulation SHO became effective on September 7, 2004. However, market participants are required to begin complying with Regulation SHO on January 3, 2005. Regulation SHO has a long compliance period to permit broker-dealers and SROs to make necessary systems changes and other order processing adjustments.
On November 29, 2004, the Commission approved an order resetting the Pilot to commence on May 2, 2005 and end on April 28, 2006. Although the Second Pilot Order resets the start date and end date for the Pilot, the other terms of the Pilot Order remain unchanged. Furthermore, the compliance date for all other provisions of Regulation SHO remains January 3, 2005.
Question 1.2: When does Regulation SHO supplant existing SRO Rules?
Answer: Regulation SHO supplants any conflicting SRO short sale rule. For example, SROs that have their own rules regarding locate and delivery have filed and are filing proposed rule changes with the Commission that will suspend such rules.
However, Regulation SHO does not conflict with SRO rules that have a purpose other than short sales. For example, NYSE Rule 80A is not directed at short sales, as such, but rather has a different purpose (i.e., reducing market volatility). For this reason, Regulation SHO does not supplant NYSE Rule 80A.
Question 1.3: How does Regulation SHO apply to overseas transactions?
Answer: Footnote 54 of the Adopting Release states that any broker-dealer using the United States jurisdictional means to effect short sales in securities traded in the United States are subject to Regulation SHO, regardless of whether the broker-dealer is registered with the Commission or relying on an exemption from registration. The Proposing Release explains that short sale regulation applies to trades in reported securities when the trades are agreed to in the United States, even if the trades are booked overseas. (68 FR at 62997 and 62998). Whether a short sale is executed or agreed to in the United States will depend on the particular facts and circumstances of the transaction. The Proposing Release provides some examples of when we would consider a short sale to have been agreed to in the United States. (68 FR at 62997 and 62998). For further information about how the provisions of Regulation SHO may apply to overseas transactions, please refer to Question 4.6.
Question 1.4: Does Regulation SHO apply to bonds?
Answer: Regulation SHO applies to short sales of equity securities. The term “equity security” is defined in Section 3(a)(11) of the Exchange Act and Rule 3a11-1 thereunder (17 CFR 240.3a11-1). A security convertible into an equity security is an equity security. Therefore, short sales of bonds that are convertible into equity would be subject to Regulation SHO. The Staff will consider on a case-by-case basis securities, including structured products, to which the “equity” status may not be clear.
Question 1.5: Do the requirements of Rule 203 of Regulation SHO apply to short sales made in connection with underwritten offerings?
Answer: Syndicate activity is not expressly addressed in Regulation SHO. However, the Staff will not recommend enforcement action for violation of Rule 203(b)(1) of Regulation SHO (locate requirement) with regard to any sale by an underwriter, or any member of a syndicate or group participating in the distribution of a security, in connection with an over-allotment of securities, or any lay-off sale by such a person in connection with a distribution of securities through rights or a standby underwriting commitment.
In addition, the Staff will not recommend enforcement action for violation of Rule 203(b)(3) of Regulation SHO (close-out and pre-borrow requirements) with respect to a net syndicate short position created in connection with a distribution of a security that is part of a fail to deliver position at a registered clearing agency in a threshold security that has persisted for 13 consecutive settlement days, if action is taken to close out the net syndicate short position no later than the 30th day after commencement of sales in the distribution.
2. Order Marking Requirements – Rule 200(g)
Question 2.1: Should a broker or dealer mark a short sale order “short exempt” if the order involves an OTCBB stock?
Answer: Rule 200(g)(2) provides that a short sale shall be marked “short exempt” if the seller is relying on an exception from the tick test of Rule 10a-1 or any short sale price test of any SRO. Securities traded on the over-the-counter bulletin board (“OTCBB”) are not subject to any short sale price tests and are therefore do not rely on an exception from such price tests. As such, they need not be marked “short exempt.” Short sales in such securities may continue to be marked “short.”
Question 2.2: May market participants presume that an “S” designation on an order indicates that an order is “sell long” and an “SS” designation on an order indicates that an order is “sell short?” Do these designations satisfy the new marking requirements under Regulation SHO?
Answer: Under Rule 200(g), brokers and dealers must mark all sell orders of any equity security as “long,” “short,” or “short exempt.” The primary objective is to make sure that orders are marked and executed properly and that accurate data on those orders is available for the pilot study and for surveillance and compliance purposes. For this reason, the Staff strongly suggests that firms use the designations specified in Rule 200(g) of Regulation SHO. The firms, however, may use other designations to identify long, short and short exempt trades, and to process the orders properly. The designations should follow a clear and consistent methodology for marking orders, and clear and accurate records must be maintained to demonstrate compliance.
Question 2.3: May a seller mark an order “long” if the seller owns the security pursuant to Rule 200(b) but is not “net long” in the security?
Answer: Rule 200(c) provides that a person shall be deemed to “own” securities only to the extent that the person has a “net long” position in such securities. Therefore, a seller must be net long in a security in order to mark “long” an order for that security. Rule 200(c) does not change the “net long” requirement of former Rule 3b-3.
(NEW! 08/28/09)
Question 2.4: How should a broker-dealer mark an order where the seller is net long for only part of the order?
Answer: A seller may be net long a security but wish to sell additional shares of that security in excess of the seller's net long position. For example, a seller may be net long 500 shares of a security but may wish to sell a total of 600 shares of that security. Under such circumstances, only 500 shares can be sold long, and the remaining 100 shares must be sold short.
Rule 200(g) of Regulation SHO requires a broker-dealer to mark sell orders in any equity security as "long" or "short." Rule 200(a) defines a short sale as "any sale of a security which the seller does not own or any sale which is consummated by the delivery of a security borrowed by, or for the account of, the seller." Rule 200(g)(1) provides that "[a]n order to sell shall be marked "long" only if the seller is deemed to own the security being sold pursuant to paragraphs (a) through (f) of this section and either: (i) The security to be delivered is in the physical possession or control of the broker or dealer; or (ii) It is reasonably expected that the security will be in the physical possession or control of the broker or dealer no later than the settlement of the transaction." Rule 200(c) of Regulation SHO provides that a person shall be deemed to own securities only to the extent that he has a net long position in such securities. In addition, to determine its own net position, Rule 200(f) requires a broker-dealer to aggregate all of its positions in a security unless it qualifies for independent trading unit aggregation.
Thus, under the above-mentioned scenario, if the seller is long 500 shares, the sell order for the sale of such 500 long shares must be marked "long" and the sell order for the sale of the additional 100 shares must be marked "short."
Furthermore, Rule 17a-3 requires, in part, that "[e]very member of a national securities exchange who transacts a business in securities …. shall make and keep current…books and records relating to its business" including a memorandum of each order which shall show the terms and conditions of the order or instructions. The memorandum must include accurate terms and conditions of the order. Thus, the order must be marked to accurately reflect that part of the order is long and part of the order is short.
(NEW! 08/28/09)
Question 2.5: How should a broker-dealer mark an order where the seller is net long 1,000 shares and wants to simultaneously enter multiple orders to sell 1,000 shares each?
Answer: Rule 200(g)(1) of Regulation SHO states that "[a]n order to sell shall be marked "long" only if the seller is deemed to own the security being sold pursuant to paragraphs (a) through (f) of this section and either: (i) The security to be delivered is in the physical possession or control of the broker or dealer; or (ii) It is reasonably expected that the security will be in the physical possession or control of the broker or dealer no later than the settlement of the transaction." Further, Rule 200(c) of Regulation SHO provides that a person shall be deemed to own securities only to the extent that he has a net long position in such securities.
Thus, we remind sellers that where a seller is net long 1,000 shares and simultaneously enters multiple orders to sell 1,000 shares owned, only one such order would constitute a long sale. After the long sale order is entered to sell the 1,000 shares, it is no longer reasonable to expect that delivery can be made by settlement date on additional orders to sell the same shares. In addition, under Rule 200(g)(1) of Regulation SHO, a broker-dealer must mark only one order as "long" and any additional orders as "short."
3. Trade Execution
Question 3.1: How should brokers and dealers process orders when the normal closing time for a regular trading day has changed (e.g., early closing of markets for holidays)?
Answer: Footnote 17 of the Pilot Order explains that 4:15 pm was designated as the end of regular trading activity for Regulation SHO because regular trading hours normally end at 4:00 pm, and an extra 15 minutes was added because trade reporting can be delayed and continue past 4:00 pm. For days when regular trading hours end earlier than 4:00 pm, the time designated as the end of regular trading for the purposes of Regulation SHO should be the time the trading hours end on those days plus 15 minutes.
4. Locate and Delivery Requirement – Rules 203(b)(1) and (2)
Question 4.1: How should broker-dealers determine “reasonableness” to satisfy the locate requirement of Regulation SHO?
Answer: Rule 203(b)(1)(ii) permits a broker or dealer to accept a short sale order in an equity security if the broker-dealer has reasonable grounds to believe that the security can be borrowed so that it can be delivered on the settlement date. “Reasonableness” is determined based on the facts and circumstances of the particular transaction. What is reasonable in one context may not be reasonable in another context. The Commission provided some examples of reasonableness in the Adopting Release. (69 FR at 48014 and Footnotes 58, 61 and 62).
Question 4.2: How may broker-dealers use Easy to Borrow lists?
Answer: The Adopting Release states that Easy to Borrow lists generally may be used to establish a reasonable basis for a locate. (69 FR at 48104). Easy to Borrow lists are prepared by a firm to indicate that firm’s ability to supply the identified securities. Therefore, for example, introducing firms may rely on Easy to Borrow lists of the clearing firms through which they clear and settle transactions unless circumstances indicate that it would not be reasonable to rely on such lists. For example, if the securities on the Easy to Borrow list have experienced delivery failures, it would not be reasonable to rely on the list. Furthermore, if the Easy to Borrow list is prepared by a clearing firm through which the introducing firm does not clear or settle transactions, or otherwise does not maintain a relationship in which the clearing firm agrees to make securities on its Easy to Borrow lists available to the introducing firm, then it would not be reasonable to rely on the list.
Question 4.3: May an executing broker rely on customer representations that a short sale is supported by a locate from the stock loan department of the executing broker, then execute the order, and then confirm the locate later in the same day or the next morning?
Answer: The executing broker has the responsibility to perform the locate prior to effecting a short sale, and must have a reasonable basis to believe that the security can be delivered on the settlement date. Footnote 58 of the Adopting Release explains that a broker-dealer may obtain an assurance from a customer that the customer can obtain securities from another identified source in time to settle the trade. The executing broker may rely on a customer’s representation that an order to sell short a security is supported by a locate obtained by the customer from the stock loan department of the executing broker, or any other identified entity that is authorized to loan stock, as long as reliance on such representation is reasonable. However, where a broker-dealer knows or has reason to know that a customer’s prior assurances resulted in failures to deliver, assurances from such customer would not provide the reasonable grounds required for a locate.
Rule 203(b)(1) requires that the executing broker document the locate. Documentation should include the source of the securities cited by the customer. Documentation should also include support for the reasonable grounds to rely on customer assurances. For example, an executing broker may provide information showing that previous borrowings arranged by the customer resulted in timely deliveries of securities to settle the customer’s transactions.
After the executing broker executes a short sale, the executing broker may take steps to confirm the locate information provided by the customer. Confirmation of the locate after the execution of a short sale may provide information on whether the locate based on customer representations was reasonable. However, confirmation after the fact is not a substitute for a locate that is required to be performed before a short sale may be executed.
(NEW! 11/04/05)
Question 4.3(B): How does a customer's history with respect to timely delivery of securities in settling short sale transactions affect a broker-dealer's "reasonable grounds" obligation under Rule 203(b)(1)?
Answer: Rule 203 requires that the executing broker has the responsibility to perform the locate prior to effecting a short sale, and must have a reasonable basis to believe that the security can be delivered on the settlement date. Reasonableness is based on the facts and circumstances of a particular transaction. In some instances, it may be reasonable for an executing broker to rely on assurances from a customer that the customer can obtain the securities from an identified source in time to settle the trade. If the executing broker knows or has reason to know that a customer's prior assurances resulted in failures to deliver, however, reliance on further assurances from that customer would not be reasonable.
Rule 203(b)(1) requires that the locate be made and documented prior to effecting any short sale, including the broker-dealer's reasonable grounds to believe that the security can be borrowed so that it can be delivered on the date delivery is due. Information important to assessing the broker-dealer's "reasonable grounds" includes information about whether securities were delivered on a timely basis for settlement in situations where the broker-dealer relied on representations from the customer to support its locate. Accordingly, the executing broker-dealer must consider information, either from its own records or from the records of its clearing firm, about settlement of the customer's trades. It would not be reasonable for an executing broker to assert that it did not know or have reason to know whether a customer's prior short sale trades resulted in delivery failures if the executing broker made no reasonable effort to obtain such information. See Footnote 58 of the Adopting Release.
If the executing broker discovered that the customer's prior assurances resulted in a single failure to deliver, the executing broker should consider the relevant facts and circumstances to determine whether it would be reasonable to rely on the customer's assurances for other transactions. For example, it may be reasonable for an executing broker to rely on the customer's assurances if the circumstances of the fail in a prior transaction were unusual, or if previous locates relying on the customer's assurances resulted in timely deliveries of securities to settle the customer's transactions and the fail in the prior transaction was an anomaly.
(NEW! 10/10/06)
Question 4.3(C): May firms rely on pre-existing agreements, such as standing instruction letters or blanket assurances, with customers when complying with the locate requirements of Rule 203(b)(1) of Regulation SHO?
Answer: Rule 203(b)(1) of Regulation SHO provides that a "broker or dealer may not accept a short sale order in an equity security from another person, or effect a short sale in an equity security for its own account, unless the broker or dealer has: (i) Borrowed the security, or entered into a bona-fide arrangement to borrow the security; or (ii) Reasonable grounds to believe that the security can be borrowed so that it can be delivered on the date delivery is due; and (iii) Documented compliance with this paragraph (b)(1)." Thus, the broker-dealer has the responsibility to perform the locate prior to effecting each short sale.
To comply with the rule, the broker-dealer must perform the locate prior to, and on the same day that, the broker-dealer effects each short sale. For example, the broker-dealer must perform a new locate when a Good Till Cancel ("GTC") short sale order requiring a locate cannot be effected on the same day that the locate was performed. Moreover, the broker-dealer may not rely on a pre-existing agreement with another source in lieu of this trade-by-trade determination.
In addition, the rule requires that broker-dealers document, at a minimum, the identity of the source, as well as the fact that the locate was performed prior to, and on the same day that, the broker-dealer effected the short sale. The rule also requires documentation of the number of shares located. We understand, however, that documenting the specific number of shares located may be problematic for systems reasons. In such circumstances, the broker-dealer must be able to demonstrate, upon request of SRO or Commission staff, that the locate: (1) was performed prior to, and on the same day that, the broker-dealer effected the short sale; (2) the short sale did not exceed the number of shares located, and (3) that there were reasonable grounds to rely on the locate.
Footnote 58 of the Adopting Release provides that a broker-dealer may obtain an assurance from a customer that such party can obtain securities from another identified source in time to settle the trade. As discussed in more detail in Question 4.3(B), that customer assurance may in some circumstances provide the "reasonable grounds" required by Rule 203(b)(1)(ii). Where the broker-dealer is relying on a customer assurance, the broker-dealer must demonstrate, upon request of SRO or Commission staff, that it confirmed that the customer performed the locate prior to, and on the same day that, the broker-dealer effected the short sale. The broker-dealer may not rely on a pre-existing agreement, such as a standing instruction letter or blanket assurance, with a customer when complying with the locate requirements of the rule, but must obtain the customer's individual assurance prior to, and for, each short sale.
Question 4.4: May an executing broker-dealer re-apply a locate for intra-day buy-to-cover trades?
Answer: A locate for a security may be re-applied for an intra-day buy-to-cover trade in the following scenario:
Prior to a customer’s short sale of 100 shares of XYZ stock, the executing broker-dealer obtains an appropriate locate for the securities. The short sale is then executed. Subsequently that day, the broker-dealer purchases 100 shares of XYZ stock for the customer, and the customer’s net trading position is flat. If the customer wants to then sell short another 100 shares of XYZ stock in the same trading day, the executing broker-dealer may apply the original locate to that sale, provided that such subsequent short sale is for an amount of securities that is no greater than the amount of securities obtained in the original locate, and provided further that the source of the located shares indicates that the original locate is good for the entire trading day.
For a "hard to borrow" security or a threshold security, a broker-dealer may not re-apply a locate for intra-day buy-to cover trades. Without obtaining locates prior to each short sale in such securities in the scenario described above, it is unlikely that the broker-dealer executing such trades would have reasonable grounds to believe that such securities can be borrowed so that they can be delivered on the date that delivery is due on each trade. A broker-dealer, however, may have reasonable grounds to believe that securities will be available when delivery is due on such short sales if the broker-dealer pre-borrows the securities.
Question 4.5: Does the locate requirement apply to convertible securities?
Answer: The locate requirement applies to all equity securities. The term “equity security” is defined in Section 3(a)(11) of the Exchange Act and Rule 3a11-1 thereunder (17 CFR 240.3a11-1). A security convertible into an equity security is an equity security; therefore, such convertibles would be subject to the locate requirement. The Staff will consider on a case-by-case basis securities, including structured products, to which the “equity” status may not be clear.
A convertible security that is subject to the locate requirement may qualify for an exception. Rule 203(b)(2)(ii) provides an exception from the uniform locate requirement for situations in which a broker-dealer effects a sale on behalf of a customer that is deemed to “own” the security although, through no fault of the customer or the broker-dealer, it is not reasonably expected that the security will be in the physical possession or control of the broker-dealer by the settlement date. The Adopting Release states that such circumstances could include the situation where a convertible security, option, or warrant has been tendered for conversion or exchange, but the underlying security is not reasonably expected to be received by the settlement date. (69 FR at 48015). In such situation, delivery should be made on the sale as soon as all restrictions on delivery have been removed, and in any event within 35 days after trade date. If delivery is not made within 35 days after the trade date, the broker-dealer that sold on behalf of the person must either borrow securities or close out the open position by purchasing securities of like kind and quantity.
(NEW! 8/28/09)
Question 4.6: May a U.S. broker-dealer that executes orders on behalf of a foreign broker-dealer rely on a locate provided by such foreign broker-dealer in the same way that the U.S. broker-dealer may rely on a locate provided by a U.S. broker-dealer?
Answer: Rule 203(b)(1)(ii) permits a broker-dealer to accept a short sale order in an equity security from another person if the broker-dealer has reasonable grounds to believe that the security can be borrowed so that it can be delivered on the date delivery is due. Subject to certain requirements, Rule 203(b)(2)(i) provides an exception to the locate requirement for short sale orders received by a registered broker-dealer from another registered broker-dealer. This "broker to broker" exception applies only to transactions undertaken between broker-dealers registered in the U.S. pursuant to the requirements of Rule 15(a) of the Securities Exchange Act of 1934.
U.S. broker-dealers must treat an assurance from a non-U.S. registered broker-dealer that it obtained a source of securities that can be delivered in time for settlement in the same manner as an assurance originating from a non-broker-dealer customer. For instance, the U.S. broker-dealer must have a reasonable belief that the securities will be available for delivery on the date delivery is due. Moreover, the U.S. broker-dealer must document this information. Consistent with Footnote 58 of the Regulation SHO Adopting Release (Release No. 50103), the documentation should include the source of the securities obtained by the foreign broker-dealer and support for the reasonableness of the U.S. broker-dealer's reliance on the foreign broker-dealer's assurances. See also FAQs 4.3(B) and 4.3(C). For further information about how the provisions of Regulation SHO may apply to overseas transactions, please refer to Question 1.3.
Question 4.7: Market makers, as defined in Section 3(a)(38) of the Exchange Act, include block positioners. Regulation SHO provides an exception to the locate requirement for market makers. Are all block positioners excepted from the locate requirement?
Answer: Rule 203(b)(2)(iii) provides an exception from the locate requirement for short sales effected by market makers, but only in connection with bona-fide market making activities. Rule 203(c)(1) provides that the term “market maker” has the same meaning as in Section 3(a)(38) of the Exchange Act, which defines “market maker” as “any specialist permitted to act as a dealer, any dealer acting in the capacity of a block positioner, and any dealer that, with respect to a security, holds itself out (by entering quotations in an inter-dealer communications system or otherwise) as being willing to buy and sell such security for its own account on a regular or continuous basis.”
The term “block positioner” is not defined in Regulation SHO or the Exchange Act. However, for purposes of Regulation SHO, the Staff interprets this term to have the same meaning as in Rule 3b-8(c) of the Exchange Act (17 CFR 240.3b-8(c)), which defines a “qualified block positioner” as a dealer that: (1) is a broker or dealer registered pursuant to Section 15 of the Exchange Act; (2) is subject to and in compliance with Rule 15c3-1 of the Exchange Act (17 CFR 240.15c3-1); (3) has and maintains minimum net capital, as defined in Rule 15c3-1, of $1,000,000; and (4) except when such activity is unlawful, meets all of the following conditions: (i) engages in the activity of purchasing long or selling short, from time to time, from or to a customer (other than a partner or a joint venture or other entity in which a partner, the dealer, or a person associated with such dealer, as defined in Section 3(a)(18) of the Exchange Act, participates) a block of stock with a current market value of $200,000 or more in a single transaction, or in several transactions at approximately the same time, from a single source to facilitate a sale or purchase by such customer, (ii) has determined in the exercise of reasonable diligence that the block could not be sold to or purchased from others on equivalent or better terms, and (iii) sells the shares comprising the block as rapidly as possible commensurate with the circumstances.
Therefore, block positioners may rely on the exception to the locate requirement in connection with bona-fide block positioning activities.
Question 4.8: What constitutes “bona-fide market making activities?”
Answer: The term “bona-fide market making” refers to bona-fide activities described in Section 3(a)(38) of the Exchange Act. Whether activity is “bona-fide” will depend on the facts and circumstances of the particular activity. However, the Adopting Release sets forth examples of activities that would not be considered to be “bona-fide market making activities.” (69 FR at 48015).
Question 4.9: How does the locate requirement apply to short sales of securities in a Rule 144 transaction?
Answer: Rule 203(b)(2)(ii) provides an exception from the uniform locate requirement for situations in which a broker-dealer effects a sale on behalf of a customer that is deemed to “own” the security although, through no fault of the customer or the broker-dealer, it is not reasonably expected that the security will be in the physical possession or control of the broker-dealer by the settlement date. Footnote 71 of the Adopting Release states that one such situation is where a customer owns stock that was formerly restricted, but presently may be sold pursuant to the provisions of Rule 144 under the Securities Act of 1933 (17 CFR 230.144). Rule 144 securities may not be capable of being delivered on settlement date due to processing to remove the restricted legend. In such situation, delivery should be made on the sale as soon as all restrictions on delivery have been removed, and in any event within 35 days after trade date. If delivery is not made within 35 days after the trade date, the broker-dealer that sold on behalf of the person must either borrow securities or close out the open position by purchasing securities of like kind and quantity.
(NEW - 07/06/07)
Question 4.10: A broker-dealer wishes to execute customer orders internally at a price that would trade through one or more protected quotations on other trading centers, but pursuant to Regulation NMS, is able to do so only if it simultaneously routes one or more ISOs to execute against the full displayed size of each of such better-priced quotations. Where the ISO is a short sale ISO, is the broker-dealer required to obtain a "locate" (i.e., have reasonable grounds to believe that the securities to be sold short are available for borrowing), as required by Rule 203(b)(1) of Regulation SHO?
Answer: In certain circumstances, a broker-dealer facilitating a customer order may be required under Regulation NMS to effect a ISO, while the broker-dealer is short the stock. Rule 203(b) of Regulation SHO provides that a broker or dealer may not accept a short sale order in an equity security from another person, or effect a short sale in an equity security for its own account, unless the broker or dealer has borrowed the security or entered into a bona-fide arrangement to borrow the security, or has reasonable grounds to believe the security can be borrowed so that it can be delivered on the date delivery is due. Regulation SHO includes an exception from the locate requirement, in Rule 203(b)(3)(iii), for short sales effected by market makers in connection with bona-fide market making activities.
The Staff has previously indicated that because market makers, as defined in Section 3(a)(38) of the Exchange Act, include block positioners, the exception from the locate requirement also applies to short sales effected by block positioners in connection with bona fide block positioning activities. See Regulation SHO FAQ 4.7. The block positioner exception allows block positioners to facilitate customer orders in a fast moving market without possible delays associated with complying with the locate requirement.
A broker-dealer that submits a short sale ISO as a result of facilitating a customer order in the following circumstances would not be required to comply with the locate requirement in connection with the ISO, even if the customer order being facilitated was not necessarily of block size and the broker-dealer was not necessarily acting in the capacity of a block positioner or market maker:
* a broker-dealer that sells to facilitate a customer purchase at a price that would trade through one or more protected quotations on other trading centers and submits a principal sell short ISO to execute against the full displayed size of each such better-priced quotation pursuant to Rule 611;
* a broker-dealer that agrees to purchase from a customer at a price that would trade through one or more protected quotations on other trading centers and submits a principal sell short ISO to execute against the full displayed size of each such better-priced quotation pursuant to Rule 611.
In addition, a broker-dealer that agrees to facilitate two customers in an agency cross transaction at a price that would trade through one or more protected quotations on other trading centers may agree with the customers that the broker will send principal sell short ISOs to execute against the full displayed size of each such better-priced quotation pursuant to Rule 611. A short sale ISO submitted in such circumstances solely to comply with Rule 611 is also excepted from the locate requirement.
In all of the examples described above, the locate exception is limited to the short sale ISO only. There is no exemption from the locate requirement for any short sale executed to facilitate the customer order. For example, if the broker-dealer is routing a short sale ISO for its principal account but owes any executions it receives to customer orders, and the customer orders are short sales, the locate exception does not apply to the customer short sale. The broker-dealer must continue to comply with the locate requirements of Rule 203(b)(1) with regard to that order.
This interpretive guidance is strictly limited to a broker-dealer's submission of a short sale ISO under the facts presented above, and any other short sales by the broker-dealer or customer would be required to comply with the Regulation SHO locate requirement, unless the broker-dealer or customer is otherwise entitled to rely on another exception in Rule 203(b)(2) of Regulation SHO. In the event that the broker-dealer's short sale ISO in a "threshold security" resulted in a fail-to-deliver position at a registered clearing agency, such fail position would be subject to the close-out requirement of Rule 203(b)(3) of Regulation SHO.
5. Close-Out and Pre-Borrow Requirements – Rule 203(b)(3)
Question 5.1: Does the close-out requirement apply to open fail positions in securities that exist prior to January 3, 2005?
Answer: The Adopting Release states that the requirement to close out fail to deliver positions in threshold securities that remain for 13 consecutive settlement days does not apply to any positions that were established prior to the security becoming a threshold security. (69 FR at 48018, and Rule 203(b)(3)(i)). On January 3, 2005, no securities will have been identified as threshold securities. Therefore, open fail positions in securities that exist prior to January 3, 2005 will not be required to be closed out under Regulation SHO. However, this does not affect the obligation of sellers of securities to deliver those securities to buyers under existing delivery and settlement guidelines.
As explained in Question 6.1, on January 3, 2005, the SROs will begin the calculations necessary to determine whether securities qualify as threshold securities. January 10, 2005 is the first day on which SROs will publish threshold lists. Until a security appears on a threshold list for 13 consecutive settlement days and an open fail position for such security exists for those days, Regulation SHO does not require a broker or dealer to close out the open fail position. Therefore, the first day on which a close-out action would be required is January 28, 2005.
Question 5.2: Must an open fail position be closed out if a security is not a threshold security on the trade date but later appears on a threshold list? Must an open fail position be closed out if a security is a threshold security on the trade date but later does not appear on a threshold list?
Answer: The close-out and pre-borrow requirements of Regulation SHO are based on settlement days, not trade days. Under Regulation SHO, it is irrelevant whether a security is a threshold security on the date that it is sold short. The close-out and pre-borrow requirements apply if a security is a threshold security for 13 consecutive settlement days and a participant in a registered clearing agency has open delivery failures in that security on each of those days.
For example, if a participant sells short a security that is not a threshold security on the date of sale, the close-out and pre-borrow requirements would not apply to a fail to deliver position on the participant’s net short settlement obligation unless the security later becomes a threshold security and it maintains that status for 13 consecutive settlement days and the participant has delivery failures for all of those days. On the other hand, a participant must close out a fail to deliver position in a threshold security that has persisted for 13 consecutive settlement days irrespective of the dates of the participant’s trades in that security. If the security ceases to be a threshold security prior to the 13th consecutive settlement day that a participant has a fail position in the security, there would be no obligation under Regulation SHO to close out the fail position.
Question 5.3: Does the close-out requirement apply to delivery failures that do not occur at a registered clearing agency?
Answer: We interpret the close-out requirement to apply only to fail to deliver positions at a registered clearing agency. Our interpretation is based on our understanding that transactions conducted outside the Continuous Net Settlement System (“CNS”) operated by the National Securities Clearing Corporation (“NSCC”) are rare. If this historical pattern changes and a significant level of fails are not included in CNS, we will reconsider this position.
Question 5.4: When entering into an arrangement to pre-borrow a threshold security, must a firm clean up the entire amount of the fail before accepting additional orders to sell short such threshold security? Or, may the firm effect short sale orders up to the amount of shares of the threshold security that is pre-borrowed?
Answer: Under Rule 203(b)(3), when a participant of a registered clearing agency has a net settlement failure in a threshold security for 13 consecutive settlement days, two consequences follow: (1) the participant must immediately take steps to close out the fail to deliver position; and (2) until the fail to deliver position is closed out, the participant and any broker or dealer for which it clears transactions must borrow the security that is the subject of the fail, or enter into a bona-fide arrangement to borrow such security before the participant or such broker or dealer may effect any subsequent short sales in such security. This pre-borrow requirement remains in place until the participant closes out the entire fail to deliver position. Therefore, a participant that has a close-out obligation for a threshold security may effect short sale orders for such threshold security up to the amount pre-borrowed.
Rule 203(b)(3)(iv) permits the participant to reasonably allocate a portion of a fail to deliver position to another registered broker or dealer for which it clears trades or for which it is responsible for settlement, based on such broker’s or dealer’s short position. If the participant has reasonably allocated the fail to deliver position, the provisions of Rule 203(b)(3) relating to such fail to deliver position shall apply to the portion of such registered broker or dealer that was allocated the fail to deliver position, and not to the participant.
Question 5.5: When must the close-out be initiated?
Answer: Rule 203(b)(3) provides that participant of a registered clearing agency that has a net settlement failure in a threshold security for 13 consecutive settlement days must immediately take steps to close out the fail to deliver position. The close-out process must be initiated no later than the beginning of trading on the trading day following the 13th consecutive settlement day with a net short settlement obligation.
Question 5.6: If a threshold security also qualifies as an “owned” security within the meaning of Rule 203(b)(2)(ii), when should the firm close out the short position: after the 13th consecutive settlement day; or the day that is 35 days after the trade date?
Answer: The close-out requirement that applies to threshold securities in Rule 203(b)(3)(iii) is based on net short positions, not trade dates. If a participant of a registered clearing agency has a fail to deliver position at a registered clearing agency in a threshold security for 13 consecutive settlement days, the participant must take action to close out the fail to deliver position after the 13th consecutive settlement day (see Question 5.5), and, until the close-out obligation is satisfied, the participant must pre-borrow securities prior to effecting any subsequent short sales in such threshold security (see Question 5.4).
The close-out requirement that applies to “owned” securities in Rule 203(b)(2)(ii), however, is a sale-based provision that does not apply directly to net short positions and is not limited to sales of threshold securities. It provides an exception from the locate requirement for a short sale of an “owned” security, provided that the broker or dealer has been reasonably informed that the person intends to deliver such security as soon as all restrictions on delivery have been removed. If the person has not delivered such security within 35 days after the date of sale, the broker or dealer that effected the sale must borrow securities or close out the short position by purchasing securities of like kind and quantity.
These close-out requirements operate independently and concurrently. Therefore, if an “owned” security is a threshold security, the security must be delivered within 35 days of the trade date, and a fail to deliver position in that security must be closed out after 13 consecutive settlement days of delivery failures.
(NEW! 05/24/05)
Question 5.7: If a participant of a registered clearing agency has a fail to deliver position at a registered clearing agency in a threshold security for 13 consecutive settlement days and immediately thereafter purchases securities of like kind and quantity to close out the fail to deliver position as required under Rule 203(b)(3), will the participant be deemed to have satisfied the close-out obligation on the day the purchase is executed, or on the day the purchase settles?
Answer: Rule 203(b)(3) provides that a participant of a registered clearing agency that has a fail to deliver position in a threshold security for 13 consecutive settlement days must immediately thereafter close out the fail to deliver position by purchasing securities of like kind and quantity. Until the close-out obligation is satisfied, a participant must pre-borrow securities to effect any new short sales in such threshold securities.
The Staff interprets the phrase "purchasing securities of like kind and quantity" in Rule 203(b)(3) to mean that a participant satisfies the obligation to close out an open fail to deliver position in a threshold security that has persisted for 13 consecutive settlement days when such participant executes a purchase of securities, and where:
* the purchase is a bona fide transaction;
* the purchase is executed on settlement day 11, 12 or 13;
* the purchase is submitted to a registered clearing agency for settlement;
* the purchase is of a quantity of securities sufficient to close out the entire amount of the open fail position that has persisted for 11, 12 or 13 consecutive settlement days, as applicable; and
* the net purchases of the threshold security effected by the participant on that day, as reflected in such participant's books and records, are at least equal to the amount of such participant's open fail to deliver position in such threshold security on that day.
Purchases to close out fail to deliver positions in threshold securities must be bona-fide purchases. Rule 203(b)(3)(v) provides that where a participant enters into an arrangement with another person to purchase securities to close out an open fail to deliver position in a threshold security, and the participant knows or has reason to know that the other person will not deliver securities in settlement of the purchase, the participant will not be deemed to have fulfilled the close-out requirements of Rule 203(b)(3).
The Staff's interpretation that a participant satisfies the close-out obligation on the day when such participant executes a purchase of securities applies only to fail positions that are or are projected to be subject to the close-out requirements of Rule 203(b)(3); i.e., to purchases made on settlement day 11, 12, or 13. Therefore, this interpretation does not apply to purchases made on settlement day 10 or earlier, because there is no present or projected close-out requirement and such purchases would settle on or before 13 consecutive settlement days has elapsed.
(NEW! 03/17/06)
Question 5.8: If a participant of a registered clearing agency has a fail to deliver position at a registered clearing agency in a threshold security at the end of each day for 13 consecutive settlement days, but during the 13-day period the participant experiences a reduction in its end of day fail to deliver position at NSCC, how should the participant apply that reduction to its open fail position(s)?
Answer: Rule 203(b)(3) of Regulation SHO requires a participant to close out a fail to deliver position in a threshold security that has persisted for 13 consecutive settlement days by purchasing securities of like kind and quantity. A participant's close-out requirement is determined by the change in the participant's end-of-day net fail to deliver position, in excess of any grandfathered amount, as recorded at NSCC that has remained open for 13 consecutive settlement days. In determining its close-out requirement, the participant must look to its total fails position at NSCC and not to fails positions at the customer account level.
If, prior to the 13th consecutive settlement day, the participant reduces its open fail to deliver position and such reduction is reflected in the participant's end-of-day net fail to deliver position at NSCC, the participant may first apply the reduction to the most recent increase in its fail to deliver position reflected at NSCC and then to any increase in its fails position that existed at NSCC on the day preceding that day and so forth until the entire amount of the reduction has been applied. If the participant wishes to apply any reduction reflected in its end-of-day net fail to deliver position at NSCC, the participant must do so in accordance with the methodology described in this Question 5.8.
Example
In this example, the participant has a fail to deliver position at NSCC of 5,000 shares in threshold security X that is subject to both increases and decreases during the 13 consecutive settlement day period. Assume, in this example, that there is no grandfathered amount.
Settlement Day Participant's End-of-Day Fail to Deliver Position Increase/(Reduction) in Fail to Deliver Position from Previous Settlement Day Participant's Close-out Requirement
1 5,000 5,000 0
2 5,000 0 0
3 5,500 500 0
4 5,500 0 0
5 5,500 0 0
6 5,500 0 0
7 5,900 400 0
8 5,300 (600) 0
9 5,300 0 0
10 5,300 0 0
11 10,000 4,700 0
12 10,000 0 0
13 10,000 0 5,000
14 10,000 0 0
15 10,000 0 300
16 5,000 (5,000) 0
17 5,000 0 0
18 4,700 (300) 0
19 4,700 0 0
20 4,700 0 0
21 4,700 0 0
22 4,700 0 0
23 4,700 0 4,700
24 4,700 0 0
25 4,700 0 0
26 0 (4,700) 0
In the above example, the participant has three separate increases in its fail to deliver position at NSCC that persist for 13 consecutive settlement days and must be closed out by the participant at the end of the 13th settlement day following the day of the increase, or on the morning of the 14th settlement day following the day of the increase, by purchasing shares of like kind and quantity.
The participant has an initial increase in its fail to deliver position of 5,000 shares that persists for 13 consecutive settlement days and must be closed out at the end of the 13th settlement day following the day of the increase, or on the morning of the 14th settlement day following the day of the increase.
In addition, the participant's fail to deliver position increases by 500 shares to 5,500 and then again by 400 shares to 5,900 shares on settlement days 3 and 7, respectively. On settlement day 8, however, the participant's end of day fail to deliver position reflects a 600 shares reduction from the prior day. This 600 shares reduction is applied first to the 400 shares increase on settlement day 7 and the excess amount of 200 shares is then applied to the 500 shares increase on settlement day 3. As a result of the 600 shares reduction at NSCC, the 400 shares increase in the participant's position that occurred on day 7 is reduced to 0 and the 500 shares increase in the participant's position that occurred on day 3 is reduced to 300. There are no further reductions in the participant's end-of-day net fail to deliver position. Thus, the 300 shares increase must be closed out at the end of the 13th settlement day following the day of the increase to 500 shares, or on the morning of the 14th settlement day following the day of the increase to 500 shares.
On settlement day 11, the participant's fail to deliver position is 10,000 shares, an increase of 4,700 shares from the prior settlement day. The participant's position then decreases by 5,000 shares on settlement day 16 as a result of the purchase to close out the 5,000 share open fail position that occurred on day 1 and that has persisted for 13 consecutive settlement days. On settlement day 18, the participant's fail to deliver position decreases to 4,700 shares, a 300 shares reduction from the prior settlement day, as a result of the purchase to close out the 300 shares open fail to deliver position that has persisted for 13 consecutive settlement days. On settlement day 26, the participant's fail to deliver position decreases to 0 shares, a 4,700 shares reduction from the prior settlement day, as a result of the purchase to close out the 4,700 shares increase in the participant's fail to deliver position that occurred on settlement day 11 and that has persisted for 13 consecutive settlement days.
Although there are reductions in the participant's fail to deliver position at NSCC on settlement days 16, 18 and 26, these reductions are as a result of the participant fulfilling its close out requirement of 5,000, 300 and 4,700 shares, respectively, at the end of the 13th settlement day and, therefore, are not allocated to prior increases in the participant's fail to deliver position.
To the extent that a reduction in a participant's fail to deliver position at NSCC is equal to, and results from, a prior close out requirement, the participant may not allocate the reduction to prior increases in its fail to deliver position because the participant has already received credit for such reduction due to the reduction being applied to the amount of the participant's close out requirement. If, however, the reduction in the participant's fail to deliver position at NSCC is greater than the amount of the participant's close out requirement, the participant may allocate any amount in excess of the close out requirement in accordance with this Question 5.8.
6. Threshold Securities – Rule 203(c)(6)
Question 6.1: Who is responsible for providing lists of threshold securities? When will the threshold lists be provided?
Answer: The SROs will disseminate threshold lists that will contain securities that are listed on their market systems and that exceed the specified fail level for at least five consecutive settlement days. A threshold security is expected to appear on one list. If a threshold security is listed on more than one market system, we understand that the SROs have agreed that the security will appear only on the threshold list of the SRO that maintains the primary listing.
On January 3, 2005, the SROs will begin the calculations necessary to determine whether securities may qualify as threshold securities. This process is described in greater detail in Question 6.2. On January 10, 2005, the SROs should disseminate the first threshold lists. SROs are expected to disseminate their threshold lists before the commencement of each trading day. We understand that the SROs have agreed to make all their lists publicly available at or before midnight each trading day. Therefore, these threshold lists will be in effect for the open of trading immediately following the posting of the threshold lists. We further understand that SROs will make threshold data available on their web sites in a downloadable, uniform, pipe-delimited ASCII format.
Question 6.2: How will SROs determine which securities should be included on a threshold list?
Answer: Any equity security of an issuer that is registered under Section 12 or that is required to file reports pursuant to Section 15(d) of the Exchange Act could qualify as a threshold security. Therefore, threshold securities may include those equity securities that trade on the OTCBB or on the pink sheets, as well as those that trade on the exchanges or Nasdaq.
At the conclusion of each settlement day, NSCC will provide the SROs with data on securities that have aggregate fails to deliver at NSCC of 10,000 shares or more. For the securities for which it is the primary market, each SRO will use this data to calculate whether the level of fails is equal to at least 0.5% of the issuer’s total shares outstanding of the security. If, for five consecutive settlement days, such security satisfies these criteria, then such security will be a threshold security. Each SRO should include such security on its daily threshold list until the security no longer qualifies as a threshold security.
(NEW! 05/06/05)
7. Clearance and Settlement
Question 7.1: Do naked short sale transactions create "counterfeit shares?"
Answer: Some believe that naked short sale transactions cause the number of shares trading to exceed the number of shares outstanding, which in turn allows broker-dealers to trade shares that don't exist. Others believe that the U.S. clearance and settlement system, and specifically the National Securities Clearing Corporation's ("NSCC") Continuous Net Settlement System ("CNS"), produces "phantom" or "counterfeit" securities by accounting for fails to deliver.
Naked short selling has no effect on an issuer's total shares outstanding. There is significant confusion relating to the fact that the aggregate number of positions reflected in customer accounts at broker-dealers may in fact be greater than the number of securities issued and outstanding. This is due in part to the fact that securities intermediaries, such as broker-dealers and banks, credit customer accounts prior to delivery of the securities. For most securities trading in the U.S. market, delivery subsequently occurs as expected. However, fails to deliver can occur for a variety of legitimate reasons, and flexibility is necessary in order to ensure an orderly market and to facilitate liquidity. Regulation SHO is intended to address the limited situations where fails are a potential problem (for example, fails in securities on a threshold list).
Similarly, CNS has no effect on an issuer's total shares outstanding. With regards to the contention that the U.S. clearance and settlement system, and specifically NSCC's CNS system, creates counterfeit shares, this is not the case. CNS is essentially an accounting system that indicates delivery and receive obligations among its members (i.e., broker-dealers and banks). These obligations do not reflect ownership positions until such time as delivery of shares are actually made. Ownership positions are reflected on the records of The Depository Trust Company ("DTC").
Question 7.2: Does NSCC's stock borrow program ("SBP") create "counterfeit shares"?
Answer: The SBP was implemented in the late 1970s to allow NSCC to satisfy its members' priority needs for stocks that they do not receive because of fails. It is governed by NSCC rules approved by the Commission. Under the SBP, NSCC uses shares voluntarily made available to the SBP by some of its members to complete deliveries to members that did not receive their securities on settlement day. The SBP moves securities that are actually on deposit at DTC from the lending member to the NSCC member who did not receive securities. NSCC then records the lender's right to receive the same amount of shares that it loaned just as if the lender had purchased securities but not received them (i.e., the member lending the securities replaces the member receiving the loaned securities in the CNS system). The lending and delivery of shares through the SBP, however, does not relieve the member that has failed to deliver from its obligation to deliver securities.
The shares loaned by NSCC members for use in the SBP must be on deposit at DTC and are debited from members' accounts when the securities are used to make delivery. Once a member's shares are used for delivery to another member, the lending member no longer has the right to sell or relend those shares until such time as the shares are returned to its DTC account. Accordingly, NSCC's SBP does not create "counterfeit shares." In fact, the program facilitates the delivery of securities to buyers while maintaining the obligation of the sellers to deliver securities to NSCC. This outcome is consistent with the NSCC's obligation to facilitate the prompt and accurate clearance and settlement of securities transactions and in general to protect investors and the public interest.
Question 7.3: Should NSCC buy-in all fails to deliver in CNS?
Answer: A "fail to deliver" in NSCC's CNS occurs when an NSCC member (e.g., a broker-dealer or a bank) fails to deliver securities on settlement date. There are many reasons why NSCC members do not or cannot deliver securities to NSCC on the settlement date. Many times the member will experience a problem that is either unanticipated or is out of its control, such as (1) delays in customer delivery of shares to the broker-dealer; (2) an inability to borrow shares in time for settlement; (3) delays in obtaining transfer of title; (4) an inability to obtain transfer of title; and (5) deliberate failure to produce stock at settlement which may result in a broker-dealer not receiving shares it had purchased to fulfill its deliver obligations. In addition, market makers may maintain temporary short positions in CNS until such time as there is sufficient trading to flatten out their position.
NSCC does not have the authority to execute buy-ins on behalf of its members. Moreover, forcing close-outs of all fails can increase risk in clearing and settling transactions as well as potentially interfering with the trading and pricing of securities.
http://www.sec.gov/divisions/marketreg/mrfaqregsho1204.htm
Key Points About Regulation SHO
Date: April 11, 2005
I. Short Sales
A. What is a short sale?
A short sale is generally the sale of a stock you do not own (or that you will borrow for delivery).1 Short sellers believe the price of the stock will fall, or are seeking to hedge against potential price volatility in securities that they own.
If the price of the stock drops, short sellers buy the stock at the lower price and make a profit. If the price of the stock rises, short sellers will incur a loss. Short selling is used for many purposes, including to profit from an expected downward price movement, to provide liquidity in response to unanticipated buyer demand, or to hedge the risk of a long position in the same security or a related security.
B. Example of a short sale.
For example, an investor believes that there will be a decline in the stock price of Company A. Company A is trading at $60 a share, so the investor borrows shares of Company A stock at $60 a share and immediately sells them in a short sale. Later, Company A's stock price declines to $40 a share, and the investor buys shares back on the open market to replace the borrowed shares. Since the price is lower, the investor profits on the difference -- in this case $20 a share (minus transaction costs such as commissions and fees). However, if the price goes up from the original price, the investor loses money. Unlike a traditional long position — when risk is limited to the amount invested — shorting a stock leaves an investor open to the possibility of unlimited losses, since a stock can theoretically keep rising indefinitely.
C. How does short selling work?
Typically, when you sell short, your brokerage firm loans you the stock. The stock you borrow comes from either the firm's own inventory, the margin account of other brokerage firm clients, or another lender. As with buying stock on margin,2 your brokerage firm will charge you interest on the loan, and you are subject to the margin rules. If the stock you borrow pays a dividend, you must pay the dividend to the person or firm making the loan.
D. Are short sales legal?
Although the vast majority of short sales are legal, abusive short sale practices are illegal. For example, it is prohibited for any person to engage in a series of transactions in order to create actual or apparent active trading in a security or to depress the price of a security for the purpose of inducing the purchase or sale of the security by others. Thus, short sales effected to manipulate the price of a stock are prohibited.
II. "Naked" Short Sales
In a "naked" short sale, the seller does not borrow or arrange to borrow the securities in time to make delivery to the buyer within the standard three-day settlement period. 3 As a result, the seller fails to deliver securities to the buyer when delivery is due (known as a "failure to deliver" or "fail").
Failures to deliver may result from either a short or a long sale. There may be legitimate reasons for a failure to deliver. For example, human or mechanical errors or processing delays can result from transferring securities in physical certificate rather than book-entry form, thus causing a failure to deliver on a long sale within the normal three-day settlement period. A fail may also result from naked short selling. For example, market makers who sell short thinly traded, illiquid stock in response to customer demand may encounter difficulty in obtaining securities when the time for delivery arrives.
Naked short selling is not necessarily a violation of the federal securities laws or the Commission's rules. Indeed, in certain circumstances, naked short selling contributes to market liquidity. For example, broker-dealers that make a market in a security4 generally stand ready to buy and sell the security on a regular and continuous basis at a publicly quoted price, even when there are no other buyers or sellers. Thus, market makers must sell a security to a buyer even when there are temporary shortages of that security available in the market. This may occur, for example, if there is a sudden surge in buying interest in that security, or if few investors are selling the security at that time. Because it may take a market maker considerable time to purchase or arrange to borrow the security, a market maker engaged in bona fide market making, particularly in a fast-moving market, may need to sell the security short without having arranged to borrow shares. This is especially true for market makers in thinly traded, illiquid stocks such as securities quoted on the OTC Bulletin Board,5 as there may be few shares available to purchase or borrow at a given time.
III. Regulation SHO
Compliance with Regulation SHO began on January 3, 2005. Regulation SHO was adopted to update short sale regulation in light of numerous market developments since short sale regulation was first adopted in 1938. Some of the goals of Regulation SHO include:
* Establishing uniform "locate" and "close-out" requirements in order to address problems associated with failures to deliver, including potentially abusive "naked" short selling.
o Locate Requirement: Regulation SHO requires a broker-dealer to have reasonable grounds to believe that the security can be borrowed so that it can be delivered on the date delivery is due before effecting a short sale order in any equity security.6 This "locate" must be made and documented prior to effecting the short sale.
o "Close-out" Requirement: Regulation SHO imposes additional delivery requirements on broker-dealers for securities in which there are a relatively substantial number of extended delivery failures at a registered clearing agency7 ("threshold securities"). For instance, with limited exception, Regulation SHO requires brokers and dealers that are participants of a registered clearing agency8 to take action to "close-out" failure-to-deliver positions ("open fails") in threshold securities that have persisted for 13 consecutive settlement days.9 Closing out requires the broker or dealer to purchase securities of like kind and quantity. Until the position is closed out, the broker or dealer and any broker or dealer for which it clears transactions (for example, an introducing broker)10 may not effect further short sales in that threshold security without borrowing or entering into a bona fide agreement to borrow the security (known as the "pre-borrowing" requirement).
* Temporarily suspending Commission and SRO11 short sale price tests12 in a group of securities to evaluate the overall effectiveness and necessity of such restrictions. The Commission will study the impact of relaxing the price tests for a period of one year.13
* Creating uniform order marking requirements for sales of all equity securities. This means that orders you place with your broker-dealer must be marked "long," "short," or "short exempt."14
IV. Threshold Securities
A. The Basics
1. What is a Threshold Security?
Threshold securities are equity securities that have an aggregate fail to deliver position for:
* five consecutive settlement days at a registered clearing agency (e.g., National Securities Clearing Corporation (NSCC));15
* totaling 10,000 shares or more; and
* equal to at least 0.5% of the issuer's total shares outstanding.16
Threshold securities only include issuers registered or required to file reports with the Commission ("reporting companies").17 Therefore, securities of issuers that are not registered or required to file reports with the Commission, which includes the majority of issuers on the Pink Sheets,18 cannot be threshold securities. This is because the SROs need to look to the total outstanding shares of the issuer in order to calculate whether or not the securities meet the definition of a "threshold security." For non-reporting companies, reliable information on total outstanding shares is difficult to determine.
2. Who is Responsible for Identifying Threshold Securities?
Regulation SHO requires the SROs to disseminate a daily list of threshold securities where such SRO, or its market center,19 is the primary listing venue for any such security.
3. Where Can I Find Threshold Lists?
Each SRO is responsible for providing the threshold securities list for those securities for which the SRO is the primary market. You can obtain SRO threshold lists at the following websites:
Nasdaq: http://www.nasdaqtrader.com/aspx/regsho.aspx (includes Nasdaq issues, OTCBB, and other OTC issues)
NYSE: http://www.nyse.com/Frameset.html?displayPage=/threshold/
AMEX: http://www.amex.com/amextrader/tradingData/RegSHO/TrDa_RegSHO.jsp (Amex listed securities only)
CSE: http://www.chx.com/publications/reg_sho.htm
ArcaEx: http://www.tradearca.com/traders/regsho_th.asp
The Boston Stock Exchange, Philadelphia Stock Exchange and National Stock Exchange are not the primary listing exchange for any securities at this time and, therefore, are currently not publishing threshold securities lists.
4. Inclusion on, and Removal from, Threshold Lists.
At the conclusion of each settlement day, NSCC provides the SROs with data on securities that have aggregate fails to deliver at NSCC of 10,000 shares or more. For the securities for which an SRO is the primary market, that SRO calculates whether the level of fails for each security is equal to, or greater than, 0.5% of the issuer's total shares outstanding of the security. If, for five consecutive settlement days, such security satisfies these criteria, then such security is a threshold security. Each SRO includes such security on its daily threshold list until the aggregate fails level for the security falls below these levels for five consecutive days. (See below for a discussion as to why a security may appear or remain on a threshold list.)
5. Implementation Dates for Threshold Lists.
The SROs disseminated the first threshold lists on January 10, 2005. Regulation SHO does not require a broker or dealer to close-out the open fail position until a security appears on a threshold list for 13 consecutive settlement days and an open fail position for such security exists for each of those days.. Therefore, the first day on which a close-out action could have been required for a threshold security was January 28, 2005.
6. Mandatory Close-Outs of Threshold Securities.
Regulation SHO requires broker-dealers to close-out all failures to deliver that exist in threshold securities for thirteen consecutive settlement days by purchasing securities of like kind and quantity ("close-out").20
Until the position is closed out, the broker or dealer and any broker or dealer for which it clears transactions (for example, an introducing broker),21 may not effect further short sales in that threshold security without borrowing or entering into a bona fide agreement to borrow the security (known as a "pre-borrowing" requirement).
7. Key Points to Remember.
Any equity security of an issuer that is registered or required to file reports with the Commission could qualify as a threshold security. Therefore, threshold securities may include equity securities:
* listed on an exchange, 22
* quoted on Nasdaq,23 or
* quoted on the OTCBB.24
Whether or not a security is a threshold security does not affect the Commission's ability to prosecute manipulative or fraudulent activity that may have occurred before or after adoption of Regulation SHO.
B. Reasons Why A Security May Appear on a Threshold List
A security's appearance on a threshold list does not necessarily mean that any improper activity has occurred or is occurring. An equity security will appear on a threshold list if it meets the definition of a threshold security set forth in Regulation SHO, meaning that failures to deliver the stock (i.e. to the party on the other side of the trade) have reached an aggregate of 10,000 shares or greater at NSCC for five consecutive settlement days and are equal to 0.5% of total shares outstanding;
C. Reasons Why A Security May Stay on a Threshold List for Longer Than 13 Consecutive Settlement Days
Even when broker-dealers close-out delivery failures, a security may remain on an SRO's threshold securities list for longer than 13 days. Examples of why securities may remain on the threshold securities list:
* after broker-dealers close-out all delivery failures, the security stays on the threshold list for five consecutive days;
* new delivery failures resulting from long or short sales may have crossed the threshold, keeping the security on the SRO's threshold securities list; or
* the delivery failures at NSCC may have been established prior to a security's appearance on the SRO's threshold securities list, and are grandfathered from the close-out requirement of Regulation SHO.
For information about specific securities, contact the appropriate SRO or its market center listed above.
D. Reasons Why A Security With a Large Short Position May Not Appear on a Threshold List
There are various reasons why an equity security with a large short position may not appear on an SRO's threshold securities list, 25 for example:
* the aggregate delivery failures do not meet the definition of a threshold security in Regulation SHO;
* the security's issuer is not registered or required to file reports with the Commission. For instance, the majority of issuers quoted on the Pink Sheets do not file reports or register with the Commission, and so would not appear on threshold lists.26
E. Who Do I Contact For More Information About Securities On a Threshold List?
If you have a question regarding a security on a particular SRO's threshold security list, contact that SRO directly. The following SROs are publishing threshold securities lists:
* for a particular OTCBB or Pink Sheet security on the threshold list, you may call NASD Market Operations at (866) 776-0800 or send an email to nasdmarketoperations@nasd.com;
* for a particular NYSE listed security, you may contact NYSE at RegSHOQ@nyse.com;
* for a particular Amex listed security, you may e-mail regsho@amex.com;
* for a particular ArcaEx security, you may call ArcaEx Clearing Hotline at (312) 442-7989 or send an e-mail to exchangesecop@archipelago.com;
* for a particular CHX security, you may e-mail regshoinfo@chx.com.
F. Grandfathering Under Regulation SHO
The requirement to close-out fail to deliver positions in threshold securities that remain for 13 consecutive settlement days does not apply to positions that were established prior to the security becoming a threshold security. This is known as "grandfathering." For example, open fail positions in securities that existed prior to the effective date of Regulation SHO on January 3, 2005 are not required to be closed out under Regulation SHO.
The grandfathering provisions of Regulation SHO were adopted because the Commission was concerned about creating volatility where there were large pre-existing open positions. The Commission will continue to monitor whether grandfathered open fail positions are being cleaned up under existing delivery and settlement guidelines or whether further action is warranted.
It is important to note that the "grandfathering" clause of the Regulation does not affect the Commission's ability to prosecute violations of law that may involve such securities or violations that may have occurred before the adoption of Regulation SHO or that occurred before the security became a threshold security.
V. Answers to Frequently-Asked Questions from Investors
1. Is all naked short selling abusive or illegal?
When considering naked short selling, it is important to know which activity is the focus of discussion.
* Selling stock short without having located stock for delivery at settlement. This activity would violate Regulation SHO, except for short sales by market makers engaged in bona fide market making. Market makers do not have to locate stock before selling short, because they need to be able to provide liquidity. However, market makers are not excepted from Regulation SHO's close-out and pre-borrow requirements.
* Selling stock short and failing to deliver shares at the time of settlement. This activity doesn't necessarily violate any rules. There are legitimate reasons why a seller may fail to deliver on the scheduled settlement date.
* Selling stock short and failing to deliver shares at the time of settlement with the purpose of driving down the security's price. This manipulative activity, in general, would violate various securities laws, including Rule 10b-5 under the Exchange Act. Regulation SHO does not address this issue.
2. Is naked short selling the reason my stock has lost value?
Investors should always use caution before investing in high-risk, speculative stocks, especially with regard to their retirement portfolios, because all stocks may decline in value. There are many reasons why a stock may decline in value. The value of a stock is determined by the basic relationship between supply and demand. If many people want a stock (demand is high), then the price will rise. If a few people want a stock (demand is low), then the price will fall. The main factor determining the demand for a stock is the quality of the company itself. If the company is fundamentally strong, that is, if it is generating positive income, its stock is less likely to lose value.
Speculative stocks, such as microcap stocks, often have a high probability of declining in value and a low probability of experiencing above average gains.27 For example, investors should take extra care to thoroughly research any company quoted exclusively in the Pink Sheets.28 With the exception of a few foreign issuers, the companies quoted in the Pink Sheets tend to be closely held, extremely small or thinly traded. Most do not meet the minimum listing requirements for trading on a national securities exchange, such as the New York Stock Exchange or the Nasdaq Stock Market. Many of these companies do not file periodic reports or audited financial statements with the SEC, making it very difficult for investors to find reliable, unbiased information about those companies.
There also may be instances where a company insider or paid promoter provides false and misleading excuses for why a company's stock price has recently decreased. For instance, these individuals may claim that the price decrease is a temporary condition resulting from the activities of naked short sellers. The insiders or promoters may hope to use this misinformation to move the price back up so they can dump their own stock at higher prices. Often, the price decrease is a result of the company's poor financial situation rather than the reasons provided by the insiders or promoters.
Naked short selling, however, can have negative effects on the market. Fraudsters may use naked short selling as a tool to manipulate the market. Market manipulation is illegal.29 The SEC has toughened its rules and is vigilant about taking actions against wrongdoers.30 Fails to deliver that persist for an extended period of time may result in a significantly large unfulfilled delivery obligation at the clearing agency where trades are settled. Regulation SHO is intended to address these effects by reducing the number of potential failures to deliver, and by limiting the time in which a broker can permit a fail to deliver to persist. For instance, as explained above, Regulation SHO requires brokers and dealers to close-out the open fail-to-deliver positions in "threshold securities" (i.e., securities that have experienced a substantial number of extended delivery failures) that have persisted for 13 consecutive settlement days.
3. Do all failures to deliver reflect improper activity that should be closed out?
A "fail to deliver" occurs when a broker-dealer fails to deliver securities to the party on the other side of the transaction on settlement date. There are many justifiable reasons why broker-dealers do not or cannot deliver securities on settlement date. A broker-dealer may experience a problem that is either unanticipated or is out of its control, such as (1) delays in customers delivering their shares to a broker-dealer, (2) the inability to obtain borrowed shares in time for settlement, (3) issues related to the physical transfer of securities, or (4) the failure of a broker-dealer to receive shares it had purchased to fulfill its delivery obligations. Fails to deliver can result from both long and short sales.
Regulation SHO was designed to target potentially problematic failures to deliver. Prevention of fails is the goal of the locate requirement. Regulation SHO requires broker-dealers to identify a source of borrowable stock before executing a short sale in any equity security with the goal of reducing the number of situations where stock is unavailable for settlement. But, because the locate is usually done three days before settlement, the stock may not be available from the source at the time of settlement, possibly resulting in a fail.
Regulation SHO also requires some fail positions to be closed out. When a broker-dealer has a fail position in a "threshold security," and that fail position has persisted for 13 consecutive settlement days, the broker-dealer must take immediate steps to close-out the fail by purchasing securities of like kind and quantity. Even market makers that have such persistent fails in threshold securities must close-out their positions.
4. Is it a violation of law when trades do not settle on T+3?
Generally, investors must complete or "settle" their security transactions within three business days. This settlement cycle is known as "T+3," shorthand for "trade date plus three days."
T+3 means that when you buy a security, your payment must be received by your brokerage firm no later than three business days after the trade is executed. When you sell a security, you must deliver your securities, in certificated or electronic form, to your brokerage firm no later than three business days after the sale.
The three-day settlement date applies to most security transactions, including stocks, bonds, municipal securities, mutual funds traded through a brokerage firm, and limited partnerships that trade on an exchange. Government securities and stock options settle on the next business day following the trade.31
Because the Commission recognized that there are many reasons why broker-dealers may fail to deliver securities on settlement date, it designed and adopted Rule 15c6-1 to prohibit broker-dealers from contracting to settle transactions later than T+3. However, failure to deliver securities on T+3 does not violate the rule.
5. Does inclusion of a stock on the threshold list mean that improper trading is occurring in the stock?
The appearance of a security on a threshold list does not necessarily mean that there has been abusive naked short selling or any impermissible trading in the stock. Delivery failures can be caused by both long and short sales. In addition, notwithstanding actions by broker-dealers to close-out delivery failures, certain securities may remain on an SRO's threshold securities list for an extended period for a variety of legitimate reasons, such as:
* Despite proper action to close-out fails, new delivery failures from long or short sales, at the same or other broker-dealers, result in the security staying on the threshold list;
* One or more broker-dealers may have temporary but legitimate problems in obtaining the stock they borrowed in time for delivery;
* Long sellers may have difficulty in producing stock in good deliverable form to their broker-dealer;
* The delivery failures were established prior to a security's appearance on the SRO's threshold securities list, and thus are "grandfathered" from the close-out requirement.
6. Should all equity securities with high levels of fails appear on a threshold list?
Although Regulation SHO's locate provision applies to all equity securities, the close-out provisions and inclusion on a threshold securities list apply only to equity securities of companies required to register or file reports with the Commission ("reporting companies").32 As described above, reporting companies typically trade on an exchange or are quoted on the Nasdaq or OTCBB. Only some reporting companies are quoted on the Pink Sheets.33 Regulation SHO is limited to reporting companies because of the difficulty in obtaining accurate total shares outstanding data for non-reporting companies.
7. Does grandfathering permit illegal activity to go unaddressed?
Regulation SHO does not require close-outs of "grandfathered" fails. As noted above, "grandfathered" status applies where the fail position was established prior to the security becoming a threshold security. However, any new fails in a security on the threshold list are subject to the mandatory close-out provisions.
Any grandfathered position that resulted from illegal activity, such as manipulation, continues to be fully subject to redress by the Commission.34 The Commission will continue to monitor whether grandfathered open fail positions are being cleaned up under existing delivery and settlement guidelines or whether further action is warranted.
8. Do the issuers of threshold securities have "problems?"
Inclusion on the threshold list simply indicates that the aggregate failures to deliver in an issuer's equity securities have reached the level required to become a "threshold security" as defined in Regulation SHO. Inclusion on the list should not be interpreted as connoting anything negative about the particular issuer.
9. Will close-out purchases required by Regulation SHO drive up a security's price?
Close-out purchases of stock on threshold securities lists will not necessarily drive up prices of such stocks. One of the primary purposes of Regulation SHO is to clean up open fail positions in threshold securities when they reach a relatively low aggregate level, but not to cause short squeezes. The term "short squeeze" refers to the pressure on short sellers to cover their positions as a result of sharp price increases or difficulty in borrowing the security the sellers are short. The rush by short sellers to cover produces additional upward pressure on the price of the stock, which then can cause an even greater squeeze. Although some short squeezes may occur naturally in the market, a scheme to manipulate the price or availability of stock in order to cause a short squeeze is illegal.
To date, there has been little evidence of rapid and unusual upward price movement in threshold stocks.
10. Where can I obtain information on short sale positions?
The SROs publish monthly statistics on short interest in securities that trade on their markets.35 Short interest is the aggregate number of open short sale positions. Short interest does not address the number of fails to deliver that may have occurred or may occur in connection with these short sales.
Short interest for NYSE stocks can be found at: http://www.nyse.com/marketinfo/datalib/1022221393023.html#moshortint. You also can learn the short interest for individual stocks that trade on the NYSE, American Stock Exchange, and Nasdaq at http://www.nasdaqtrader.com/asp/short_interest.asp or by visiting the NasdaqTrader's website at www.nasdaqtrader.com.
There also are many commercial websites and some newspapers that offer this information. If you enter the words "short interest" into most Internet search engines, you'll quickly find websites that can provide this information.
11. Can I obtain fails information?
Currently, threshold lists include the name and ticker symbol of securities that meet the threshold level on a particular settlement date. Some investors have requested that the SROs provide more detailed information for each threshold security, including the total number of fails, the total short interest position, the name of the broker-dealer firm responsible for the fails, and the names of the customers of responsible brokers and dealers responsible for the short sales. The fails statistics of individual firms and customers is proprietary information and may reflect firms' trading strategies. The release of this information could be used to engage in unlawful upward manipulation of the price of the securities in order to "squeeze" the firms improperly.
12. I read on an internet chat room or website that a specific security has a large number of fails; are these sources reliable?
Investors should always be cautious that issuers, promoters, or shareholders may be seeking to stimulate buying interest by making false, misleading or unfounded statements in internet chat rooms or other such forums about alleged large naked short positions in some smaller issuers, particularly those trading on the OTCBB or Pink Sheets. Some individuals may encourage other investors to buy these issuers' securities by claiming that there will be an imminent "short squeeze," in which the alleged naked short sellers will be forced to cover open short positions at increasing prices. These claims in fact may be false.
The Commission's Office of Investor Education and Assistance has made available publications on the Commission's Internet web site (www.sec.gov) that provide helpful guidance on the securities markets and sales and trading practices, including short selling. Investors and prospective investors should be cautious of rumors on chat rooms where the intent of nameless and faceless computer users is in doubt.
13. Where can I find information on specific issuers or securities?
To find information on issuers and securities, see http://www.sec.gov/investor/pubs/easyaccess.htm.
14. Does NSCC's stock borrow program create "counterfeit shares?"
NSCC's stock borrow program, as approved by the Commission, permits NSCC to borrow securities from its participants for the purpose of completing settlements only if participants have made those securities available to NSCC for this purpose and those securities are on deposit in the participant's account at DTC.
15. Where can I submit information on potential violations of the federal securities laws?
If you have specific enforcement-related information, please see http://www.sec.gov/complaint.shtml for information on how to submit a complaint. You may also call 1-800-SEC-0330.
16. Where can I find information on investigations or enforcement actions pending against specific issuers or regarding specific securities?
As a policy, the SEC will neither confirm nor deny the existence of an investigation unless, and until, it becomes a matter of public record as the result of a court action or administrative proceeding. SEC investigations are conducted on a non-public and confidential basis to help assure the integrity of the investigative process. See http://www.sec.gov/investor/pubs/howoiea.htm for more information on how the Commission handles complaints.
To view enforcement actions that the Commission has taken, see http://www.sec.gov/litigation/litreleases.shtml.
VI. Reporting Alleged Abusive Naked Short Selling Activity
The markets and the SROs are primarily responsible for the surveillance and enforcement of trading activity pursuant to their rules. The SEC, however, independently or in conjunction with the SROs and other regulatory authorities, actively investigates and prosecutes violations of the federal securities laws.
The SEC takes information alleging violations of the federal securities laws very seriously. If you have specific enforcement-related information, please send it in an email to enforcement@sec.gov. Please note, however, the SEC will neither confirm nor deny the existence of an investigation unless, and until, it becomes a matter of public record as the result of a court action or administrative proceeding. As you may also be aware, SEC investigations are conducted on a non-public and confidential basis to help assure the integrity of the investigative process. See http://www.sec.gov/investor/pubs/howoiea.htm for more information on how the Commission handles complaints.
VII. Regulation SHO – Releases and Other Guidance
The final adopting release for Regulation SHO and other key documents relating to short sale regulation, such as the "Frequently Asked Questions Regarding Regulation SHO" published by the Staff of the Division of Market Regulation, are available on the Commission's website at: http://www.sec.gov/spotlight/shortsales.htm.
The NasdaqTrader has also issued guidance on Regulation SHO through a Frequently Asked Questions release on its website at: http://www.nasdaqtrader.com/trader/hottopics/RegSHOFAQs.pdf.
VIII. Who Do I Contact If I Have Questions about Regulation SHO?
Individual investors who have comments or information should feel free to contact the SEC's Office of Investor Education and Assistance at 1-800-SEC-0330 or (202) 942-7040. Investors can also file complaints at http://www.sec.gov/complaint.shtml.
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1 For more information on short sales, see http://www.sec.gov/answers/shortsale.htm.
2 For information regarding margin, please see http://www.sec.gov/answers/margin.htm.
3 For more information on the three-day settlement period, also known as "T+3," see http://www.sec.gov/answers/tplus3.htm and http://www.sec.gov/investor/pubs/tplus3.htm.
4 For more information about market making, see http://www.sec.gov/answers/mktmaker.htm and http://www.sec.gov/answers/specialist.htm.
5 For more information on the OCTBB, see http://www.sec.gov/answers/otcbb.htm.
6 Broker-dealers engaged in bona-fide market making are excepted from having to borrow or arrange to borrow shares due to their potential need to facilitate customer orders in fast-moving markets without possible delays associated with complying with Regulation SHO. For instance, as explained above, they may be required by their market making obligations to sell short in situations where it may be difficult to quickly locate and borrow securities. However, this exception is limited. For example, bona-fide market making does not include activity that is related to speculative selling strategies or investment purposes of the broker-dealer or that is disproportionate to the usual market making patterns or practices of the broker-dealer in that security. Further, bona-fide market making does not include transactions whereby a market maker enters into an arrangement with another broker-dealer or customer in an attempt to use the market maker's exception for the purpose of avoiding compliance with Regulation SHO by the other broker-dealer or customer.
7 Clearing Agencies are self-regulatory organizations that are required to register with the Commission. There are two types of clearing agencies -- clearing corporations and depositories. Clearing corporations compare member transactions (or report to members the results of exchange comparison operations), clear those trades and prepare instructions for automated settlement of those trades, and often act as intermediaries in making those settlements. Depositories hold securities certificates in bulk form for their participants and maintain ownership records of the securities on their own books. Clearing corporations generally instruct depositories to make securities deliveries that result from settlement of securities transactions. In addition, depositories receive instructions from participants to move securities from one participant's account to another participant's account, either for free or in exchange for a payment of money. See http://www.sec.gov/divisions/marketreg/mrclearing.shtml and www.dtcc.com for more information about the clearance and settlement process and DTCC.
8 A participant of a clearing agency means any person or firm, such as a broker-dealer, that uses a clearing agency to clear and settle securities transactions or to transfer, pledge, lend, or hypothecate securities. It does not include a person or firm whose only use of a clearing agency is (a) through another person or firm that is a participant or (b) as a pledge of securities. Section 3(a)(24) of the Exchange Act, 15 U.S.C. 78c(a)(24).
9 Settlement day means any business day on which deliveries of securities and payments of money may be made through the facilities of a registered clearing agency.
10 Introducing brokers are typically brokers that perform all the functions of a broker except for the ability to accept money, securities, or property from a customer. They are usually not participants of registered clearing agencies and do not perform clearance and settlement functions. See Footnote 9 for more information about participants of a clearing agency.
11 A self-regulatory organization is a membership-based organization that creates and enforces rules for its members based on the federal securities laws. SROs, which are overseen by the SEC, are the front line in regulating broker-dealers. See http://www.sec.gov/about/whatwedo.shtml for more information.
12 For example, the tick test of Rule 10a-1 of the Securities Exchange Act of 1934 provides that, subject to certain exceptions, an exchange-listed security may only be sold short: (i) at a price above the immediately preceding reported price ("plus tick"), or (ii) at the last sale price if it is higher than the last different reported price ("zero-plus tick"). The New York Stock Exchange has a similar tick test under NYSE Rule 440B, and NASD has a bid test under NASD Rule 3350.
13 Specifically, the price tests will be relaxed for securities included on a list of approximately 1,000 actively-traded securities, and after-hours trading (4:15 p.m. until the open of the consolidated tape the following day) of another list of approximately 1,000 securities. For more information on this pilot, see http://www.sec.gov/spotlight/shopilot.htm, and http://www.sec.gov/news/press/2004-164.htm.
14 Under the rule, an order can be marked "long" when the seller owns the security being sold and the security either is in the physical possession or control of the broker-dealer, or it is reasonably expected that the security will be in the physical possession or control of the broker or dealer no later than settlement. However, if a person does not own the security, or owns the security sold and does not reasonably believe that the security will be in the possession or control of the broker-dealer prior to settlement, the sale should be marked "short." The sale could be marked "short exempt" if the seller is entitled to rely on an exception from the tick test of Rule 10a-1, or the price test of an exchange or national securities association. Short sales of pilot securities effected during the pilot should be marked "short exempt."
15 The majority of equity trades in the U.S. are cleared and settled through systems administered by clearing agencies registered with the Commission. The National Securities Clearing Corporation ("NSCC"), the largest registered clearing agency for equity securities, clears and settles through its Continuous Net Settlement system ("CNS"). The CNS system nets the securities delivery obligations and the payment obligations of all clearing corporation participants. Clearing corporations notify participants of their securities delivery and payment obligations each day. In addition, the clearing corporation guarantees the completion of all transactions and interposes itself as the contraparty to both sides of any transaction. Clearance may be accomplished on a trade-by-trade basis or through netting of trades either bilaterally between the two counterparties or multilaterally among all members of a clearing corporation to yield balance orders reflecting a single day's trades or all open positions to date (continuous net settlement or "CNS"). See http://www.sec.gov/divisions/marketreg/mrclearing.shtml for more information on clearance and settlement.
16 Outstanding shares (or outstanding stock) are the total amount of shares of a corporation's stock that have been issued.
17 See http://www.sec.gov/answers/regis33.htm, http://www.sec.gov/investor/pubs/microcapstock.htm and http://www.sec.gov/info/smallbus/qasbsec.htm for more information on who is required to register and report.
18 See http://www.sec.gov/answers/pink.htm for more information about the Pink Sheets.
19 See http://www.sec.gov/answers/market.htm for information on market centers.
20 The requirement to close-out fail to deliver positions in threshold securities that remain for 13 consecutive settlement days does not apply to any positions that were established prior to the security becoming a threshold security. This is explained in more detail below.
21 Introducing brokers are typically brokers that perform all the functions of a broker except for the ability to accept money, securities, or property from a customer. They are usually not participants of registered clearing agencies. See Footnote 9 for more information about participants of a clearing agency.
22 See http://www.sec.gov/answers/market.htm for more information about the exchanges.
23 See http://www.sec.gov/answers/nasdaq.htm for more information about Nasdaq.
24 See http://www.sec.gov/answers/otcbb.htm for more information about the OTCBB.
25 These lists do not reflect short interest positions of securities. Short interest is the aggregate number of open short sale positions. Short interest does not address the number of fails to deliver that may have occurred or may occur in connection with these short sales.
26 See http://www.sec.gov/answers/noinfo.htm for more information on which companies are required to register and report.
27 See http://www.sec.gov/investor/pubs/microcapstock.htm for more information.
28 Many of these stocks are also considered "penny stocks." See http://www.sec.gov/answers/penny.htm. Because penny stocks are generally risky investments, before a broker-dealer can sell a penny stock, SEC rules require the firm to first approve the customer for the transaction and receive from the customer a written agreement to the transaction. The firm must furnish the customer a document describing the risks of investing in penny stocks. The broker-dealer must tell the customer the current market quotation, if any, for the penny stock and the compensation the firm and its broker will receive for the trade. Finally, the firm must send monthly account statements showing the market value of each penny stock held in the customer's account.
29 The Commission recently brought an enforcement action against certain parties, alleging manipulative naked short selling, in a scheme sometimes termed as a "death spiral." See Rhino Advisors, Inc. and Thomas Badian, Lit. Rel. No. 18003 (February 27, 2003) at http://www.sec.gov/litigation/litreleases/lr18003.htm.
30 See http://www.sec.gov/investor/pubs/microcapstock.htm.
31 For more information about T+3, see http://www.sec.gov/investor/pubs/tplus3.htm.
32 See http://www.sec.gov/investor/pubs/microcapstock.htm for more information.
33 See http://www.sec.gov/answers/pink.htm for more information about the Pink Sheets.
34 See http://www.sec.gov/answers/tmanipul.htm for more information on manipulation.
35 In addition, each SRO has agreed to make publicly available the trading data in connection with the pilot. The trading data will contain information on each executed short sale involving an exchange-listed or Nasdaq National Market equity security reported by an SRO to a securities information processor. For information on where to find this data, please see http://www.sec.gov/spotlight/shopilot.htm.
http://www.sec.gov/spotlight/keyregshoissues.htm
SEC Charges New Jersey Investment Adviser in Multi-Million Dollar Offering Fraud
FOR IMMEDIATE RELEASE
2010-163
Washington, D.C., Sept. 2, 2010 — The Securities and Exchange Commission today charged a Branchburg, N.J.-based investment adviser and three of her firms with operating a multi-million dollar offering fraud involving the sale of phony promissory notes to investors, many of whom are retired or unsophisticated in investments.
Additional Materials
* Litigation Release No. 21641
The SEC alleges that Sandra Venetis told some investors that the promissory notes were guaranteed by the Federal Deposit Insurance Corporation and would earn interest of approximately 6 to 11 percent per year that would be tax-free due to a loophole in the tax code. She also told investors that she would use their money to fund loans to doctors that would be backed by Medicare reimbursement payments to those doctors. Instead of making investments, Venetis looted investor funds to pay business debts and personal expenses accrued from international travel, gambling, and home mortgages and property taxes. She also funneled cash to her relatives.
Venetis and the entities have agreed to settle the SEC's charges and consent to a court order that freezes their assets and requires monetary payments including financial penalties to be determined at a later date. Venetis also agreed to an SEC administrative action that bars her from future association with any investment adviser or broker-dealer.
"Venetis abused her position of trust to target older investors who were the most vulnerable to her egregious lies and misrepresentations," said Bruce Karpati, Co-Chief of the SEC's Asset Management Unit. "The SEC's enforcement action and the settlement reached ensure that she will never work in the securities industry again."
According to the SEC's complaint filed in federal court in New Jersey, Venetis and the three entities that she founded, owned, or controlled have obtained at least $11 million from investors since approximately 1997. Systematic Financial Associates Inc. is an investment adviser, Systematic Financial Services LLC is an accounting and tax preparation firm, and Systematic Financial Services Inc. is an entity Venetis created to conduct the fraudulent offerings. Venetis, acting on behalf of the three entities, solicited and obtained funds from clients and others to invest in promissory notes, fixed income investments, or other side investments.
The SEC alleges that the representations made by Venetis to investors were entirely false and the promissory notes and other offerings were unsupported by any investments, assets, or related revenues. Venetis simply fabricated the names and signatures of "doctors" or forged signatures of other people she claimed were recipients of the loans. Venetis concealed from investors that she used their funds to pay her home mortgage and property taxes, purchase a home for her daughter, finance improvements on a home owned by her brother, pay her own gambling debts, and pay for trips to such destinations as Alaska, Italy, France, India, and the Caribbean.
The SEC's complaint charges Venetis, Systematic Financial Associates, Inc., Systematic Financial Services, LLC, and Systematic Financial Services, Inc. with unregistered sales of securities in violation of the Securities Act of 1933 and with violations of the antifraud provisions of the Securities Act and the Securities Exchange Act of 1934. The SEC also charged Venetis and Systematic Financial Associates, Inc. with violations of the antifraud provisions of the Investment Advisers Act of 1940. In addition, the SEC's complaint names three relief defendants for the purposes of recovering investor assets now in their possession: Jennifer Venetis (Venetis's daughter); Kevin Persley (Venetis's brother); and Venetis LLC (an entity owned and controlled by Venetis).
Venetis and the entities have agreed to settle the SEC's charges and have consented to all of the relief that the SEC seeks in its complaint, including the entry of a court order enjoining them from future violations of the above provisions of the securities laws, ordering the payment of disgorgement of ill-gotten gains with prejudgment interest, financial penalties, an asset freeze, accountings, and the appointment of an independent monitor. The settlement will defer the determination of the amount of the monetary relief to a later date. The settlement is not final until approved by the court.
Venetis and Systematic Financial Associates Inc. also agreed to settle related administrative actions by the Commission that will bar Venetis from association with any investment adviser or broker or dealer, and revoke the registration of the firm.
Investors involved in this matter who need more information about the SEC's enforcement action can contact the agency with their questions at 212-336-0100 or SECSystematicinfo@sec.gov.
SEC Asset Management Unit and other staff within the New York Regional Office conducted an expedited investigation. The staff includes New York-based Asset Management Unit members Ken C. Joseph, James McGovern, Catherine Lifeso, and Panayiota Bougiamas, New York Senior Trial Counsel Jack Kaufman, and examination staff members Dawn Blankenship, Danielle Ryea, Kenneth O'Connor, Beth Abraham, and Francesco Spinella.
The SEC thanks the U.S. Attorney's Office for the District of New Jersey and Federal Bureau of Investigation for their assistance in this matter. The SEC's investigation is continuing.
# # #
For more information about this enforcement action contact:
George S. Canellos
Director, SEC New York Regional Office
212-336-1020
Bruce Karpati (212-336-0104) and Robert Kaplan (202-551-4969)
Co-Chiefs of the SEC Asset Management Unit
Ken C. Joseph
Assistant Director of New York Office and member of SEC Asset Management Unit
212-336-0097
http://www.sec.gov/news/press/2010/2010-163.htm
SEC Charges Pinnacle Capital Markets for Deficient Customer Identification Program Procedures
FOR IMMEDIATE RELEASE
2010-161
High-Res Photo
View high-resolution photo of Robert Khuzami, Director, SEC Enforcement Division
“If a broker-dealer provides customers with direct access to the U.S. securities markets, it must comply with the applicable customer identification rules.”
Robert Khuzami
Director
SEC Enforcement Division
Washington, D.C., Sept. 1, 2010 — The Securities and Exchange Commission today charged Pinnacle Capital Markets LLC with failing to comply with an anti-money laundering (AML) rule that requires broker-dealers to identify and verify the identities of its customers and document its procedures for doing so. The SEC also charged Pinnacle's managing director Michael A. Paciorek with causing Pinnacle's violations.
Additional Materials
* SEC's Order Against Pinnacle
In a parallel action also announced today, the Financial Crimes Enforcement Network (FinCEN) assessed a penalty against Pinnacle for violating the Bank Secrecy Act (BSA).
Pinnacle is a broker-dealer based in Raleigh, N.C., with more than 99 percent of its customers residing outside the United States. Pinnacle's business primarily involves order processing with direct market access (DMA) software for foreign institutions comprised mostly of banks and brokerage firms and foreign individuals.
The SEC found that Pinnacle established, documented and maintained a customer identification program (CIP) that specified it would identify and verify the identities of all of its customers. However, during a six-year period, Pinnacle failed to follow the identification and verification procedures set forth in its CIP.
"Left unchecked, Pinnacle's business model yields significant money laundering risks," said Robert Khuzami, Director of the SEC's Division of Enforcement. "If a broker-dealer provides customers with direct access to the U.S. securities markets, it must comply with the applicable customer identification rules."
Thomas Sporkin, Chief of the SEC's Office of Market Intelligence, added, "Direct market access was a big selling point to Pinnacle's customers. The sub-account holders of the omnibus accounts held at Pinnacle were permitted to place trades directly in their own accounts using the DMA software and functioned as customers. The customer identification rules require that they be treated as such."
According to the SEC's order against Pinnacle, many of the firm's foreign entity customers hold omnibus accounts at Pinnacle through which the entities carry sub-accounts for their own corporate or retail customers. Pinnacle treats the sub-account holders of the foreign entity omnibus accounts in the same manner as it does its regular account holders. The vast majority of Pinnacle's regular account holders, as well as the omnibus sub-account holders, use DMA software to enter securities trades directly and instantly through their own computers. As a result, these account holders have direct, unfiltered control over how securities transactions are effected in the accounts. The foreign entity holding the omnibus account does not intermediate these trades. The DMA software allows the omnibus sub-account holders to route their securities transactions directly to the relevant market centers without intermediation.
The SEC's order finds that Pinnacle willfully violated Section 17(a) of the Securities Exchange Act of 1934 and Rule 17a-8 thereunder, which require a broker-dealer to comply with the reporting, recordkeeping and record retention requirements in regulations implemented under the BSA, including the requirements in the CIP rule applicable to broker-dealers. The CIP rule generally requires a broker-dealer to establish, document, and maintain procedures for identifying customers and verifying their identities.
The order specifically finds that from October 2003 to August 2006, Pinnacle did not verify the identities of 34 out of a sample of 55 corporate account holders. The Commission also finds that from October 2003 through November 2009, Pinnacle did not collect or verify identifying information for the vast majority of the beneficial owners of sub-accounts maintained by Pinnacle's omnibus brokerage accounts. Consequently, the order finds that Pinnacle's documented procedures differed materially from its actual procedures.
Pinnacle and Paciorek agreed to settle the SEC's enforcement action without admitting or denying the allegations, and Pinnacle will pay $25,000 in financial penalties. As part of an action taken by the Financial Industry Regulatory Authority (FINRA) in February 2010, Pinnacle also has agreed to certain undertakings, including extensive AML training for its employees, as well as the hiring of an independent consultant to review its AML compliance program.
David Smyth and Sarit Klein conducted the SEC's investigation. The SEC acknowledges the cooperation of FinCEN and FINRA in this matter.
# # #
For more information about this enforcement action, contact:
Thomas Sporkin
Chief, SEC's Office of Market Intelligence
(202) 551-4891
http://www.sec.gov/news/press/2010/2010-161.htm
SEC Issues Report Cautioning Credit Rating Agencies
FOR IMMEDIATE RELEASE
2010-159
High-Res Photo
View high-resolution photo of Robert Khuzami, Director, SEC Enforcement Division
“It is crucial that NRSROs take steps to assure themselves of the accuracy of those statements and that they have in place sufficient internal controls over the procedures they use to determine credit ratings.”
Robert Khuzami
Director
SEC Enforcement Division
Washington, D.C., Aug. 31, 2010 — The Securities and Exchange Commission today issued a report cautioning credit rating agencies about deceptive ratings conduct and the importance of sufficient internal controls over the policies, procedures, and methodologies the firms use to determine credit ratings.
The SEC's Report of Investigation stems from an Enforcement Division inquiry into whether Moody's Investors Service, Inc. (MIS) — the credit rating business segment of Moody's Corporation — violated the registration provisions or the antifraud provisions of the federal securities laws.
The Report says that because of uncertainty regarding a jurisdictional nexus between the United States and the relevant ratings conduct, the Commission declined to pursue a fraud enforcement action in this matter. The Report notes that the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act provided expressly that federal district courts have jurisdiction over SEC enforcement actions alleging violations of the antifraud provisions of the securities laws when conduct includes significant steps, or a foreseeable substantial effect, within the United States. The Report also notes that the Dodd-Frank Act amended the securities laws to require nationally recognized statistical rating organizations (NRSROs) to "establish, maintain, enforce, and document an effective internal control structure governing the implementation of and adherence to policies, procedures, and methodologies for determining credit ratings."
"Investors rely upon statements that NRSROs make in their applications and reports submitted to the Commission, particularly those that describe how the NRSRO determines credit ratings," said Robert Khuzami, Director of the SEC's Division of Enforcement. "It is crucial that NRSROs take steps to assure themselves of the accuracy of those statements and that they have in place sufficient internal controls over the procedures they use to determine credit ratings."
According to the Report, an MIS analyst discovered in early 2007 that a computer coding error had upwardly impacted by 1.5 to 3.5 notches the model output used to determine MIS credit ratings for certain constant proportion debt obligation notes. Nevertheless, shortly thereafter during a meeting in Europe, an MIS rating committee voted against taking responsive rating action, in part because of concerns that doing so would negatively impact MIS's business reputation.
MIS applied in June 2007 to be registered with the Commission as an NRSRO. The Report notes that the European rating committee's self-serving consideration of non-credit related factors in support of the decision to maintain the credit ratings constituted conduct that was contrary to the MIS procedures used to determine credit ratings as described in the MIS application to the SEC.
In the Report of Investigation, the Commission makes clear that credit rating agencies registered with the SEC must implement and follow appropriate internal controls and procedures governing their determination of credit ratings, and must also take reasonable steps to ensure the accuracy of statements in applications or reports submitted to the SEC.
The Report cautions NRSROs that, when appropriate, the Commission will pursue antifraud enforcement actions against deceptive ratings conduct, including actions pursuant to the Dodd-Frank Act provisions regarding conduct that physically occurs outside the United States but involves significant steps or foreseeable effects within the U.S.
Under Section 21(a) of the Securities Exchange Act of 1934, the Commission may investigate violations of the federal securities laws and at its discretion "publish information concerning any such violations." David Frohlich, Margaret Cain, Roger Paszamant, and Dean Conway conducted the SEC's investigation. The Commission acknowledges the assistance and cooperation of foreign regulatory authorities in Europe in this investigation.
# # #
For more information about this enforcement action, contact:
Scott W. Friestad
Associate Director, SEC's Division of Enforcement
(202) 551-4962
David Frohlich
Assistant Director, SEC's Division of Enforcement
(202) 551-4963
http://www.sec.gov/news/press/2010/2010-159.htm
SEC Charges Two Accounting Professionals at Milwaukee-Based Company with Fraud
FOR IMMEDIATE RELEASE
2010-160
High-Res Photo
View high-resolution photo of Merri Jo Gillette, Director, SEC Chicago Regional Office
“Sachdeva brazenly stole millions from Koss Corporation with Mulvaney’s assistance and then used crooked accounting to cover up the theft.”
Merri Jo Gillette
Director
SEC Chicago Regional Office
Washington, D.C., Aug. 31, 2010 — The Securities and Exchange Commission today charged two former senior accounting professionals at a Milwaukee-based headphone manufacturer with accounting fraud, books-and-records violations, and related misconduct arising from the embezzlement of more than $30 million from the company.
Additional Materials
* SEC Complaint
The SEC alleges that Sujata Sachdeva, who was the vice president of finance and principal accounting officer at Koss Corporation, stole money from company accounts to make millions of dollars in payments on her personal credit card and for other extravagant personal purchases from luxury retailers. With the assistance of Koss senior accountant Julie Mulvaney, Sachdeva concealed the theft on Koss’s balance sheet and income statement by overstating assets, expenses, and cost of sales, and by understating liabilities and sales. Based on the fraudulent records prepared by Sachdeva and Mulvaney, Koss prepared materially false financial statements and filed materially false current, quarterly, and annual reports with the SEC.
“Sachdeva brazenly stole millions from Koss Corporation with Mulvaney’s assistance and then used crooked accounting to cover up the theft,” said Merri Jo Gillette, Director of the SEC’s Chicago Regional Office. “Sachdeva and Mulvaney abused their positions of trust and defrauded Koss shareholders who rely upon corporate filings for accurate information about the company’s financial condition.”
According to the SEC’s complaint, filed in U.S. District Court for the Eastern District of Wisconsin, the scheme began in 2004 and lasted through December 2009. After discovering the embezzlement, Koss amended and restated its financial statements for fiscal years 2008 and 2009 and the first three quarters of fiscal year 2010. Both Sachdeva and Mulvaney have been terminated by the company.
The SEC’s complaint alleges that Sachdeva, a resident of Mequon, Wisc., embezzled funds from company accounts through a variety of means, including cashier’s checks, unauthorized wire transfers, and unauthorized payments from petty cash. Sachdeva fraudulently authorized the issuance of more than 500 cashier’s checks totaling more than $15 million. She used them to make approximately $10 million in payments to American Express for her personal credit card, and also used them to make direct payments to luxury retailers. At times, Sachdeva used acronyms in an attempt to conceal the identities of the check recipients — such as “N.M. Inc.” for Neiman Marcus and “S.F.A. Inc.” for Saks Fifth Avenue.
According to the SEC’s complaint, Sachdeva used the embezzled funds to finance an extravagant lifestyle, including prolific purchases of designer clothes, furs, purses, shoes, and jewelry as well as china, statues, and household furnishings. She also used the stolen funds to buy automobiles, pay for airline tickets and hotels during personal travel, and finance home improvements and renovations. Meanwhile Mulvaney, who lives in Milwaukee, concealed and facilitated the theft by preparing false journal entries to disguise Sachdeva’s misappropriation of funds.
The SEC’s complaint charges Sachdeva with violations of the antifraud provisions of the federal securities laws and charges both Sachdeva and Mulvaney with violations of the reporting, books and records and internal control provisions of the federal securities laws. The SEC seeks a permanent injunction, disgorgement of ill-gotten gains and financial penalties against Sachdeva and Mulvaney, and an order barring Sachdeva from serving as an officer or director of a public company.
Sachdeva entered into a plea agreement with the U.S. Attorney’s Office for the Eastern District of Wisconsin on July 27, 2010, in a parallel criminal proceeding and pled guilty to six counts of wire fraud. Sachdeva admitted her multi-million-dollar theft from company and her scheme to falsify the company’s accounting records to hide her embezzlement. Sachdeva is scheduled to be sentenced on Nov. 18, 2010.
The SEC’s investigation was conducted by James Davidson, Kara Washington, Michael Cabonargi and Donald Ryba of the SEC’s Chicago Regional Office. The investigation is continuing. The SEC acknowledges the assistance of the U.S. Attorney’s Office for the Eastern District of Wisconsin in this matter.
# # #
For more information about this enforcement action, contact:
Merri Jo Gillette
Director, SEC Chicago Regional Office
(312) 353-9338
Robert Burson
Associate Director, SEC Chicago Regional Office
(312) 353-7428
http://www.sec.gov/news/press/2010/2010-160.htm
SEC Freezes Assets of Two Traders in Spain for Insider Trading Around Public Announcement of BHP Acquisition Bid
FOR IMMEDIATE RELEASE
2010-153
High-Res Photo
View high-resolution photo of Daniel M. Hawke, Market Abuse Unit Chief, SEC Enforcement Division
“When abusive market practices occur, as in the case against Garcia and Sanchez, we will act swiftly and decisively to deny wrongdoers the profits of their illegal activity.”
Daniel M. Hawke
Market Abuse Unit Chief
SEC Enforcement Division
Washington, D.C., Aug. 24, 2010 — The Securities and Exchange Commission has charged two residents of Madrid, Spain with insider trading and obtained an emergency court order to freeze their assets after they made nearly $1.1 million in illegal profits by trading in advance of last week's public announcement of a multi-billion dollar cash tender offer by BHP Billiton Plc to acquire Potash Corp. of Saskatchewan Inc.
Additional Materials
* SEC Complaint
The SEC alleges that Juan Jose Fernandez Garcia and Luis Martin Caro Sanchez purchased — on the basis of material, non-public information about the impending tender offer — hundreds of "out-of-the-money" call option contracts for stock in Potash in the days leading up to the public announcement of BHP's bid on August 17. Garcia is the head of a research arm at Banco Santander, S.A. — a Spanish banking group advising BHP on its bid. Garcia and Sanchez jointly spent a little more than $61,000 to purchase the contracts in U.S. brokerage accounts. Immediately after BHP's offer was announced publicly on August 17, Garcia and Sanchez sold all of their options for illicit profits of nearly $1.1 million.
"Garcia and Sanchez tried to move off-shore highly suspicious trading profits made just a few days before. When abusive market practices occur, as in the case against Garcia and Sanchez, we will act swiftly and decisively to deny wrongdoers the profits of their illegal activity," said Daniel M. Hawke, Chief of the Enforcement Division's Market Abuse Unit.
According to the SEC's complaint filed Friday in U.S. District Court for the Northern District of Illinois and unsealed by the court today, BHP made an unsolicited $38.6 billion offer to purchase all of the stock of Potash for $130 per share in cash. The acquisition share price represented a 16 percent premium above Potash's closing price of $112.15 on August 16. Potash, based in Saskatoon, Canada, is the world's largest producer of fertilizer minerals and its stock trades on the New York Stock Exchange. BHP, based in Melbourne, Australia, is the world's largest mining company.
The SEC alleges that Garcia was in possession of material, nonpublic information regarding BHP's offer to acquire Potash while he purchased approximately 282 call option contracts for Potash stock from August 12 to 16. The majority of the contracts were set to expire on August 21, and all but six of the call option contracts purchased by Garcia were out-of-the-money. Sanchez, while in possession of material, nonpublic information regarding BHP's offer to acquire Potash, purchased approximately 331 out-of-the-money call option contracts for Potash stock on August 12 and 13. He purchased the contracts in an account at Interactive Brokers LLC — the same U.S. brokerage firm through which Garcia traded his Potash call option contracts. Sanchez's contracts were set to expire within weeks of the purchase date. Neither individual had previously traded this year in Potash securities through his account at Interactive Brokers.
The emergency court order obtained late Friday by the SEC on an ex parte basis and unsealed by the court today freezes approximately $1.1 million in assets and, among other things, grants expedited discovery and prohibits Garcia and Sanchez from destroying evidence.
The SEC alleges that Garcia and Sanchez violated Sections 10(b) and 14(e) of the Securities Exchange Act of 1934 and Rules 10b-5 and 14e-3 thereunder. In addition to the emergency relief, the Commission is seeking permanent injunctions, disgorgement of ill-gotten gains with prejudgment interest, and financial penalties.
The SEC's Market Abuse Unit headed by chief Daniel M. Hawke and deputy chief Sanjay Wadhwa conducted the expedited investigation in this matter jointly with the agency's Chicago Regional Office. Chicago-based Market Abuse Unit staff involved in the investigation include Kathryn A. Pyszka, Frank D. Goldman and Dee A. O'Hair. Other Chicago Regional Office staff involved are R. Kevin Barrett, James Lundy and Steven C. Seeger under the leadership of Regional Director Merri Jo Gillette and Associate Regional Director Timothy Warren.
The SEC's investigation is continuing.
# # #
For more information about this enforcement action, contact:
Daniel M. Hawke
Chief, Market Abuse Unit, SEC Enforcement Division
(267) 226-7081
Sanjay Wadhwa
Deputy Chief, Market Abuse Unit, SEC Enforcement Division
(212) 336-0181
Kathryn A. Pyszka
Assistant Director in SEC's Chicago Regional Office and Market Abuse Unit
(312) 353-7416
http://www.sec.gov/news/press/2010/2010-153.htm
Finra to post more broker complaints, convictions
By Associated Press
July 14, 2010
http://www.investmentnews.com/article/20100714/FREE/100719973/-1/INDaily01
Investors will soon be able to see more customer complaints, criminal convictions and rulings against brokers, a securities regulator said Tuesday.
The Financial Industry Regulatory Authority, or FINRA, said it was given approval to expand its free online BrokerCheck service by the Securities and Exchange Commission.
The changes will increase the number of complaints and disciplinary actions reported, and extend the public disclosure period for a broker who leaves the industry to 10 years from two, FINRA said. Information like criminal convictions, civil injunctive actions and arbitration awards against former brokers will be posted permanently, the regulator said.
FINRA also plans to formalize a dispute process for current and former brokers to question the accuracy or update information on the service.
"This additional information will benefit investors who are considering whether to conduct, or continue to conduct, business with a particular securities firm or broker," said FINRA Chairman and CEO Rick Ketchum in a statement. "Just as important, it will provide valuable information about persons who have left the securities industry, often not of their own accord, who have established themselves in other segments of the financial services industry and can still cause great harm to the investing public."
The expanded information will be posted in two phases.
In late August, historic complaints going back to 1999 will be added to the public records of all current and former brokers.
By the end of the year, full records will be publicly available for all brokers whose registrations were terminated within the last 10 years.
Also by the end of the year, the criminal and legal information will be added to the records of the appropriate former brokers, and the dispute process will be in place.
FINRA is the largest non-governmental regulator for all securities firms doing business in the United States. It registers and educates industry participants, examines securities firms, writes and enforces rules and federal securities laws and administers dispute resolution for investors and registered firms.
http://www.investmentnews.com/article/20100714/FREE/100719973/-1/INDaily01
Goldman Sachs to Pay Record $550 Million to Settle SEC Charges Related to Subprime Mortgage CDO
Firm Acknowledges CDO Marketing Materials Were Incomplete and Should Have Revealed Paulson's Role
FOR IMMEDIATE RELEASE
2010-123
High-Res Photo
View high-resolution photo of Robert Khuzami, Director, SEC Enforcement
“This settlement is a stark lesson to Wall Street firms that no product is too complex, and no investor too sophisticated, to avoid a heavy price if a firm violates the fundamental principles of honest treatment and fair dealing.”
Robert Khuzami
Director
SEC Enforcement
Washington, D.C., July 15, 2010 — The Securities and Exchange Commission today announced that Goldman, Sachs & Co. will pay $550 million and reform its business practices to settle SEC charges that Goldman misled investors in a subprime mortgage product just as the U.S. housing market was starting to collapse.
In agreeing to the SEC's largest-ever penalty paid by a Wall Street firm, Goldman also acknowledged that its marketing materials for the subprime product contained incomplete information.
Additional Materials
* Goldman Consent
* Proposed Judgment
* Litigation Release No. 21592
In its April 16 complaint, the SEC alleged that Goldman misstated and omitted key facts regarding a synthetic collateralized debt obligation (CDO) it marketed that hinged on the performance of subprime residential mortgage-backed securities. Goldman failed to disclose to investors vital information about the CDO, known as ABACUS 2007-AC1, particularly the role that hedge fund Paulson & Co. Inc. played in the portfolio selection process and the fact that Paulson had taken a short position against the CDO.
In settlement papers submitted to the U.S. District Court for the Southern District of New York, Goldman made the following acknowledgement:
Goldman acknowledges that the marketing materials for the ABACUS 2007-AC1 transaction contained incomplete information. In particular, it was a mistake for the Goldman marketing materials to state that the reference portfolio was "selected by" ACA Management LLC without disclosing the role of Paulson & Co. Inc. in the portfolio selection process and that Paulson's economic interests were adverse to CDO investors. Goldman regrets that the marketing materials did not contain that disclosure.
"Half a billion dollars is the largest penalty ever assessed against a financial services firm in the history of the SEC," said Robert Khuzami, Director of the SEC's Division of Enforcement. "This settlement is a stark lesson to Wall Street firms that no product is too complex, and no investor too sophisticated, to avoid a heavy price if a firm violates the fundamental principles of honest treatment and fair dealing."
Lorin L. Reisner, Deputy Director of the SEC's Division of Enforcement, added, "The unmistakable message of this lawsuit and today's settlement is that half-truths and deception cannot be tolerated and that the integrity of the securities markets depends on all market participants acting with uncompromising adherence to the requirements of truthfulness and honesty."
Goldman agreed to settle the SEC's charges without admitting or denying the allegations by consenting to the entry of a final judgment that provides for a permanent injunction from violations of the antifraud provisions of the Securities Act of 1933. Of the $550 million to be paid by Goldman in the settlement, $250 million would be returned to harmed investors through a Fair Fund distribution and $300 million would be paid to the U.S. Treasury.
The landmark settlement also requires remedial action by Goldman in its review and approval of offerings of certain mortgage securities. This includes the role and responsibilities of internal legal counsel, compliance personnel, and outside counsel in the review of written marketing materials for such offerings. The settlement also requires additional education and training of Goldman employees in this area of the firm's business. In the settlement, Goldman acknowledged that it is presently conducting a comprehensive, firm-wide review of its business standards, which the SEC has taken into account in connection with the settlement of this matter.
The settlement is subject to approval by the Honorable Barbara S. Jones, United Sates District Judge for the Southern District of New York.
Today's settlement, if approved by Judge Jones, resolves the SEC's enforcement action against Goldman related to the ABACUS 2007-AC1 CDO. It does not settle any other past, current or future SEC investigations against the firm. Meanwhile, the SEC's litigation continues against Fabrice Tourre, a vice president at Goldman.
The SEC investigation that led to the filing and settlement of this enforcement action was conducted by the Enforcement Division's Structured and New Products Unit, led by Kenneth Lench and Reid Muoio, and including Jason Anthony, N. Creola Kelly, Melissa Lamb, and Jeffrey Leasure. Additionally, together with Deputy Director Reisner, Richard Simpson, David Gottesman, and Jeffrey Tao have been handling the litigation.
# # #
For more information about this enforcement action, contact:
Robert S. Khuzami
Director, SEC Enforcement Division
(202) 551-4500
Lorin L. Reisner
Deputy Director, SEC Enforcement Division
(202) 551-4787
Kenneth R. Lench
Chief of Structured and New Products Unit, SEC Enforcement Division
(202) 551-4938
http://www.sec.gov/news/press/2010/2010-123.htm
Home | Previous Page
Chief Information Officer Charles Boucher To Leave SEC
FOR IMMEDIATE RELEASE
2010-120
Washington, D.C., July 12, 2010 —The Securities and Exchange Commission today announced that Charles Boucher has decided to leave the agency after serving as its Chief Information Officer (CIO) since 2008. His plans include not-for-profit work and completion of studies in preparation for ordination as a Deacon in his church next spring.
As CIO, Mr. Boucher has managed all of the SEC's information technology programs and systems including application development, infrastructure operations, enterprise architecture, security, and user support. Mr. Boucher and his staff in the Office of Information Technology (OIT) work with the agency's divisions and offices to incorporate technology into all SEC programs to serve investors, maintain orderly markets, and promote capital formation. OIT operates the EDGAR system, which provides investors with access to millions of public company financial statements and other corporate filings. Among other information technology initiatives during Mr. Boucher's tenure, the agency began to revamp its systems for reviewing tips, complaints, and referrals.
"Effective securities regulation depends in large part on making sense of the immense volume of data generated in our securities markets. Charlie has played an important role in building a platform to implement our new system for reviewing complaints, tips and investigative leads provided by whistleblowers or other sources," said SEC Chairman Mary L. Schapiro.
"I regard my time with the SEC as having been among the most important and rewarding of my career. It has been an honor to contribute during these challenging times, and to serve with people of the highest caliber," Mr. Boucher said. "Our country, and the world, benefit from the leadership this agency is providing to reform and better regulate our financial markets, so that they continue to expand economic opportunities for all people, and so that investors are protected."
Before coming to the SEC, Mr. Boucher was an Executive Director at Morgan Stanley, and prior to that served as Senior Vice President and Chief Information Officer of Standard & Poor's. Among other earlier positions, Mr. Boucher was a Principal for Morgan Stanley, Vice President for Salomon Brothers, and Consultant Manager for Chase Manhattan. He received his BA in management from Rutgers University and an MBA in finance from Columbia University. He served in the U.S. Army Signal Corps in the early 1970s.
# # #
http://www.sec.gov/news/press/2010/2010-120.htm
Keeping Your Account Secure: Tips for Protecting Your Financial Information
Downloadable version (PDF 106 KB)
Your brokerage firm has an obligation to safeguard your personal financial information. But even the best procedures cannot prevent all instances of identity theft—especially if the vulnerability lies with you, the customer.
This brochure, brought to you by FINRA and the Securities Industry Financial Markets Association (SIFMA), describes the critical steps you can take to safeguard your financial accounts and help prevent identity theft.
How Does Identity Theft Occur?
A host of ways. Some identity thieves use keystroke-logging software to capture usernames and passwords, disseminating these programs through instant messages, emails, or freeware. Others "phish" for sensitive information by sending phony emails that purport to come from a legitimate financial institution but which ask for information your firm would never request through email—such as confirmation of an account number, password, credit card number, or Social Security number. Still others use the old-fashioned method of "dumpster-diving" to recover your discarded account statements or other records that haven't been properly shredded.
How Can I Protect Myself?
Take the following steps to secure your brokerage accounts and your personal financial information:
* Protect Your Passwords and PINs. Do not share your passwords or PINs with others. You also should not store your passwords or PINs on your computer. If you need to write down your passwords or PINs, store them in a secure, private place. You should change your passwords and PINs regularly and use a different password and PIN for each of your accounts. Use passwords and PINs that contain numbers and letters or symbols.
* Maintain Your Computer Security. Personal firewalls and security software packages (with anti-virus, anti-spam, and spyware detection features) are a must for those who engage in online financial transactions. Make sure that your computer has up-to-date security software, including security patches, that the software is configured for automatic updates, and that the software is always turned on. For laptops, be sure to use encryption software. Computer hardware and software providers also maintain security pages on their Web sites with tips for checking and improving the security of your system.
* Use Your Own Computer. It is generally safer to access your brokerage account from your own computer. Avoid using public computers to access your brokerage account. Public computers may contain software that captures passwords and PINs, providing that information to others at your expense. If you do use another computer, be sure to delete your "Temporary Internet Files" or "Cache" and clear all of your "History" after you log off your account. You should occasionally check to make sure that no one else has attached any device or added programs to your computer without your knowledge or consent. Consult the Help function on your browser and operating system to learn how to delete this information.
* Log Out Completely. Always click the "log out" button to terminate your access to your brokerage firm's Web site. Access may not be terminated if you simply close or minimize your browser or type in a new web address when you're done using your online account. Other users of the computer might be able to re-enter the site and have access to your account online if you do not properly log out. You also potentially expose yourself to "session stealing" if you have multiple Web pages open while logged on to your brokerage account. Avoid multi-tasking on multiple Web pages when checking your financial accounts online—or, if you must visit another site, use a different type of browser rather than opening another window.
* Be Prudent When Using Wireless Connections. Wireless networks may not provide as much security as wired Internet connections. In fact, many "hotspots" — wireless networks in public areas like airports, hotels, internet cafes and restaurants — reduce their security settings so it is easier for individuals to access and use these wireless networks. This increases the possibility that someone may intercept your information. You may decide that accessing your online brokerage account through a wireless connection is not worth the security risk. If you use your own wireless network, make certain you secure the network with wireless encryption.
* Check for Secure Web Sites. When you access your brokerage account online, check to ensure that the log in page indicates that it is a secure site. The address of a secure Web site connection starts with "https" instead of just "http" and has a key or closed padlock in the status bar (which typically appears in the lower right-hand corner of your screen). When you click on the padlock, the security certificate should confirm the identity of the site you are visiting. In Microsoft Internet Explorer 7, look for the address bar to turn green.
* Be Careful Downloading. When you download a program or file from an unknown source, you risk loading malicious software programs on your computer. Download software only from sites you know. Be wary of free software because it can be accompanied by other software such as spyware. Do not install software unless you know what it is and what it does and do not click on links in pop-up windows. Using anti-spyware software helps protect you from such programs.
* Don't Respond to Emails Requesting Personal Information. Legitimate companies will not ask you to provide or verify sensitive information through email. If your financial institution actually needs personal information from you or your statement, call the company yourself — using the number in your files or on your statement, not the one the email provides! Do not respond to emails, such as "phishing" emails, seeking your password, PIN, or other personal information.
* Read Your Statements. Read all your monthly account statements (bank, brokerage, credit card, etc.) thoroughly as soon as they arrive to make sure that all transactions shown are ones that you actually made or authorized. Check to see whether all of the transactions that you thought you made appear as well. Be sure that your brokerage firm has current contact information for you, including your mailing address and email address. If you see a mistake on your statement or do not receive a statement, contact your financial institution or credit card issuer immediately and follow-up in writing, where necessary.
* Secure Your Confidential Documents. Keep all your financial documents in a secure place, and be careful how you dispose of any documents with financial or other confidential information. Shred documents that have confidential financial or identification information before throwing them away.
* Safeguard Your Social Security Number. Do not use your Social Security number as a username, password or PIN, and make sure that it does not appear on your printed checks. If your Social Security number appears on your driver's license, be sure to ask your state's Department of Motor Vehicles whether it can use an alternative number. Keep your Social Security card in a safe place and avoid carrying it with you. You should also be sure to safeguard the social security numbers of any dependents.
* Do a Periodic "Identity Theft" Check. Reviewing your credit report may alert you to inaccuracies and unauthorized activity. You can obtain a free credit report every 12 months from three different credit bureaus by contacting the Annual Credit Report Request Service at AnnualCreditReport.com. This is the only authorized online source for you to get a free credit report under federal law. Be aware that you will have to disclose your Social Security number to obtain this report.
What Should I Do If My Identity Has Been Compromised?
If you think that your personal information has been stolen, immediately contact your brokerage firm and other financial institutions, including credit card issuers, to notify them of the problem. You should also notify the credit bureaus to put a fraud alert on your file.
If you detect unauthorized transactions in or withdrawals from your brokerage account, ask the firm to investigate. Be aware that your firm will need time to determine what happened and may need your help in identifying family members or others who might have access to your account. In the meantime, be sure to change your username, password and PIN for the account.
Additional Resources
To obtain your free annual credit report:
* http://www.annualcreditreport.com
For more information on identify theft, including how to file a complaint:
* http://www.ftc.gov/bcp/edu/microsites/idtheft//index.html
For more information on phishing, spyware, and other online threats:
* http://onguardonline.gov
* http://www.sec.gov/investor/pubs/phishing.htm
For more information on smart investing:
* http://www.finra.org/investor
* http://www.pathtoinvesting.org
* http://www.sec.gov/investor.shtml
To receive the latest Investor Alerts and other important investor information sign up for Investor News.
Investors Beware of Phony SIPC “Look-Alike” Website Targeting Madoff Victims
Posted in:
The SEC is warning investors about a website that falsely claims that $1.3 billion in Madoff money has been found in Malaysia and encourages individuals to submit information to verify that they are on a refund list. The website was created as a fake mirror image of the Securities Investor Protection Corporation’s (SIPC) website.
To prevent Madoff victims from disclosing confidential financial information because they hope to recover some of their losses, SIPC issued a press release warning them about a fictitious entity known as the International Security Investor Protection Corporation (ISIPC). The ISIPC website mimics almost exactly the look, feel, and content of SIPC’s website – with one notable exception. The ISPIC website claims to partner with several legitimate governments, including the United States – linking to web pages maintained by these governments. ISIPC also falsely claims to be sponsored by the United Nations, the International Monetary Fund, the World Bank and the IBA. The IBA was the subject of an earlier investor alert.
Con artists worldwide often target investors who already have lost money in a financial fraud. These con artists rely on the victim’s desire to recoup their losses as quickly and as fully as possible, encouraging individuals to submit information to verify that they are on a refund list.
It’s not hard to figure out who the real regulators and legitimate entities are and how you can contact them. But make sure the URL matches the ones listed below:
* International Regulators – You’ll find a list of international securities regulators on the website of the International Organization of Securities Commissions (IOSCO) at http://www.iosco.org. SIPC recently has joined IOSCO as an ancillary member.
* FINRA – The federal securities laws require that virtually every securities firm doing business with the U.S. public must be a member of FINRA. You’ll find information on how FINRA registers and governs its members firm on FINRA’s website at http://www.finra.org.
* Securities
and Exchange Commission – Our website is http://www.sec.gov. You’ll find legitimate contact information for the SEC in the Contact Us section at http://www.sec.gov/contact.shtml and on SEC Division Homepages at http://www.sec.gov/divisions.shtml. If you’re ever unsure whether you’re dealing with someone from the real SEC, submit Questions and Comments Form.
* SIPC – SIPC is a non-profit organization created by Congress in 1970 to protect the customers of insolvent brokerage firms. You’ll find the real SIPC
at http://www.sipc.org/index.html.
* State and provincial regulators in Canada, Mexico, and the U.S. – You’ll find a directory on the website of the North American Securities Administrators Association (NASAA) at http://www.nasaa.org.
For more tips on investing wisely and avoiding fraud, please read Fake Seals and Phony Numbers and visit the Investor Information section of our website.
Investor Alert: Investors Beware of Entity Calling Itself “U.S. Securities and Equities Administration”
Posted in:
The staff of the United States Securities and Exchange Commission (SEC) is issuing this Investor Alert about an entity calling itself the “U.S. Securities and Equities Administration” and other similar names, including the “U.S. Securities Administration” or the “U.S. Securities Bureau.” In conversations with members of the public, the entity may have represented that its address is 225 Franklin Street, Boston, Massachusetts. The entity also claims to operate a website at www.gov.ussea.us. It appears that this entity may be requesting up-front fees to remove purported restrictions on shares of stock that investors own, or to release funds purportedly being held by the U.S. government on investors’ behalf.
Investors should beware that these entities are not United States government agencies and are not affiliated with the United States Securities and Exchange Commission.
You can find the correct contact information for the SEC in the Contact Us section of our website and on SEC Division Homepages. If you’re ever unsure whether you’re dealing with someone from the real SEC, use our online Question Form to ask us. It’s not hard to figure out who the real regulators are and how you can contact them. You’ll find a list of international securities regulators on the website of the
International Organization of Securities Commissions (IOSCO) and a directory of state and provincial regulators in Canada, Mexico, and the U.S. on the website of the North American Securities Administrators Association (NASAA). If someone encourages you to verify information about a deal with an entity that doesn’t appear on these lists, you should be wary.
Oil Spill Stock Scams—Don’t Get Cleaned Out by False Cleanup Claims
Posted in:
The oil spill in the Gulf of Mexico poses more than an environmental and economic threat to the region. It also poses a financial threat to investors in the form of scams promising financial gains from investments in companies that claim to be involved in cleanup operations.
Millions of dollars are being spent daily on short-term cleanup of the spill, which began in April 2010 with a blowout at an
oil-drilling platform off the coast of Louisiana. The cost of long-term remediation remains unknown given the uncertainty about the extent of damage to the environment, the fishing industry and tourism.
The staff of the Securities and Exchange Commission and FINRA are issuing this alert to warn investors about potential scams that exploit the Gulf oil spill and related cleanup efforts. While some of the companies touting their role in the cleanup may be legitimate, others could be bogus operations that are only looking to clean out unsuspecting investors.
In a recent action, on May 25, the SEC suspended trading in shares of ACT Clean Technologies Inc., of Huntington Beach, Calif. The Commission took this action because of questions about the accuracy and adequacy of publicly disseminated information concerning, among other things: (1) British Petroleum’s purported expression of interest in using a so-called oil fluidizer technology purportedly licensed to ACT’s wholly-owned subsidiary for use in cleanup operations in the Gulf of Mexico; and (2) the purported results of field tests finding that the oil fluidizers are effective for use in cleanup efforts in the Gulf of Mexico.
Spotting Potential Oil Spill Stock Scams:
Some companies may issue press releases, or send unsolicited faxes or spam emails that might include:
* *Claims to have products or technologies that are effective in remediating oil spills or restoring the eco-system
* Mention of contracts or expected contracts with BP, formerly British Petroleum, that will aid the cleanup effort
* Claims that the company is providing technical assistance or expertise to BP or to U.S. government agencies such as the Coast Guard or the Environmental Protection Agency
* Predictions of rapid, exponential sales growth
* Pressure to invest immediately
How to Avoid Getting Scammed:
Here are some tips to avoid potential scams:
* Investigate before you invest. Never rely solely on information contained in an unsolicited fax, email, text message or tweet—or in a blog post or online thread. It’s easy for companies or their promoters to make glorified claims about product effectiveness, lucrative contracts, or the company’s revenues, profits or future stock price.
* Find out who sent the message. Many companies and individuals that tout stocks are paid to do so by the company being touted. Examine the fine print for any statements indicating payments in cash or instock for issuing the report or message.
* Find out where the stock trades. Most unsolicited fax and spam recommendations involve stocks that do not meet the listing requirements of the major stock exchanges. Instead, they usually are quoted on the OTC Bulletin Board or in the Pink Sheets, which do not impose minimum qualitative standards. Many of the securities quoted on the OTC Bulletin Board or in the Pink Sheets trade infrequently, which can make it difficult to sell your shares. When shares on the OTC Bulletin Board or in the Pink Sheets do trade, they may move up or down in price very rapidly.
* Read a company’s SEC filings. Most public companies file quarterly and annual reports with the SEC. Check the SEC’s EDGAR database to find out if the company is filing reports to the SEC, and read them. Be aware that registering securities and filing reports with the SEC does not mean the company will be a good investment.
* Exercise some skepticism. Scammers are very adept at making their pitches appear real, including the use of slick videos and websites. Be extremely wary of any pitch that suggests immediate pay-offs, especially if the investment involves a start-up company or a product or service that is still in development.
If you’re suspicious about an offer or if you think the claims might be exaggerated or misleading, please contact us:
SEC Office of Investor Education and Advocacy
* SEC Center for Complaints and Enforcement Tips
FINRA Complaint Center
* http://www.finra.org/complaint
Additional Resources
* Hurricane-related Investment Scams
* ACT Clean Technologies, Inc. Trading Suspension (.pdf)
* Pump and Dump Schemes
* http://www.finra.org/Investors/ProtectYourself/AvoidInvestmentFraud/
Red Flags for Fraud
* If it sounds too good to be true, it is. Compare promised yields with current returns on well-known stock indexes. Any investment opportunity that claims you’ll get substantially more could be highly risky. And that means you might lose money.
* “Guaranteed returns” aren’t. Every investment carries some degree of risk, and the level of risk typically correlates with the return you can expect to receive. Low risk generally means low yields, and high yields typically involve high risk. If your money is perfectly safe, you’ll most likely get a low return. High returns represent potential rewards for folks who are willing and financially able to take big risks. Most fraudsters spend a lot of time trying to convince investors that extremely high returns are “guaranteed” or “can’t miss.” Don’t believe it.
* Beauty isn’t everything. Don’t be fooled by a pretty website – they are remarkably easy to create. If you’d like to see what an online fraud looks like, click here.
* Pressure to send money RIGHT NOW. Scam artists often tell their victims that this is a once-in-a-lifetime offer, and it will be gone tomorrow. But resist the pressure to invest quickly, and take the time you need to investigate before sending money. If it is that good an opportunity, it will wait.
What can I do to avoid being scammed?
* Ask questions and check out the answers. Fraudsters rely on the sad truth that many people simply don’t bother to investigate before they invest. It’s not enough to ask a promoter for more information or for references – fraudsters have no incentive to set you straight. Savvy investors take the time to do their own independent research.
* Research the company before you invest. You’ll want to fully understand the company’s business and its products or services before investing. Before buying any stock, check out the company’s financial statements on the SEC’s website, or contact your state securities regulator. Many public companies have to file financial statements with us. If the company doesn’t file with us, you’ll have to do a great deal of work on your own to make sure the company is legitimate and the investment appropriate for you. That’s because the lack of reliable, readily available information about company finances can open the door to fraud. Remember that unsolicited emails, message board postings, and company news releases should never be used as the sole basis for your investment decisions.
* Know the salesperson. Spend some time checking out the person touting the investment before you invest – even if you already know the person socially. Always find out whether the securities salespeople who contact you are licensed to sell securities in your state and whether they or their firms have had run-ins with regulators or other investors. You can check out the disciplinary history of brokers and advisers quickly – and for free – using the SEC’s and FINRA’s online databases. Your state securities regulator may have additional information.
* Be wary of unsolicited offers. Be especially careful if you receive an unsolicited fax or e-mail about a company — or see it praised on an Internet bulletin board — but can find no current financial information about the company from other independent sources. Many fraudsters use e-mail, faxes and Internet postings to tout thinly traded stocks, in the hopes of creating a buying frenzy that will push the share price up so that they can sell their shares. Once they dump their stock and quit promoting the company, the share price quickly falls. And be extra wary if someone you don’t know and trust recommends foreign or “off-shore” investments. When you send your money abroad, and something goes wrong, it’s more difficult to find out what happened and to locate your money.
What steps can I take to avoid Ponzi schemes and other investment frauds?
Whether you’re a first-time investor or have been investing for many years, there are some basic questions you should always ask before you commit your hard-earned money to an investment.
The SEC sees too many investors who might have avoided trouble and losses if they had asked questions from the start and verified the answers with information from independent sources.
When you consider your next investment opportunity, start with these five questions:
* Is the seller licensed?
* Is the investment registered?
* How do the risks compare with the potential rewards?
* Do I understand the investment?
* Where can I turn for help?
For more information, read Investing Smart from the Start: Five Questions to Ask Before You Invest.
What are some Ponzi scheme “red flags”?
Many Ponzi schemes share common characteristics. Look for these warning signs:
* High investment returns with little or no risk. Every investment carries some degree of risk, and investments yielding higher returns typically involve more risk. Be highly suspicious of any “guaranteed” investment opportunity.
* Overly consistent returns. Investments tend to go up and down over time, especially those seeking high returns. Be suspect of an investment that continues to generate regular, positive returns regardless of overall market conditions.
* Unregistered investments. Ponzi schemes typically involve investments that have not been registered with the SEC or with state regulators. Registration is important because it provides investors with access to key information about the company’s management, products, services, and finances.
* Unlicensed sellers. Federal and state securities laws require investment professionals and their firms to be licensed or registered. Most Ponzi schemes involve unlicensed individuals or unregistered firms.
* Secretive and/or complex strategies. Avoiding investments you don’t understand or for which you can’t get complete information is a good rule of thumb.
* Issues with paperwork. Ignore excuses regarding why you can’t review information about an investment in writing, and always read an investment’s prospectus or disclosure statement carefully before you invest. Also, account statement errors may be a sign that funds are not being invested as promised.
* Difficulty receiving payments. Be suspicious if you don’t receive a payment or have difficulty cashing out your investment. Keep in mind that Ponzi scheme promoters sometimes encourage participants to “roll over” promised payments by offering even higher investment returns.
If you are aware of an investment opportunity that might be a Ponzi scheme, contact the SEC by phone at (800) 732-0330 or online at http://www.sec.gov/complaint.shtml.
How is the SEC responding to its Office of Inspector General’s reports on the Madoff fraud?
In August and September 2009, the SEC’s Office of Inspector General issued three reports on the Madoff fraud, including one entitled Investigation of Failure of the SEC to Uncover Bernard Madoff’s Ponzi Scheme. The SEC has closely analyzed the reports.
Even before the release of these reports, major efforts were underway to make improvements and address the shortcomings that were identified in the reports. A list of decisive and comprehensive steps the SEC is taking to reduce the chances that similar frauds will occur or be undetected in the future is available on the SEC’s Post-Madoff Reforms web page.
Does the SEC investigate Ponzi schemes?
The SEC investigates and prosecutes many Ponzi scheme cases each year both to prevent new victims from being harmed and to maximize the recovery of assets to investors. The majority of such cases are brought as emergency actions, which often seek a temporary restraining order and an asset freeze.
During 2009, the SEC filed 60 enforcement actions involving Ponzi schemes or Ponzi-like payments, including charging Robert Allen Stanford and his companies with allegedly conducting an $8 billion Ponzi scheme.
How did Ponzi schemes get their name?
The schemes are named after Charles Ponzi, who duped thousands of New England residents into investing in a postage stamp speculation scheme back in the 1920s. At a time when the annual interest rate for bank accounts was five percent, Ponzi promised investors that he could provide a 50% return in just 90 days. Ponzi initially bought a small number of international mail coupons in support of his scheme, but quickly switched to using incoming funds to pay off earlier investors.
Why do Ponzi schemes collapse?
With little or no legitimate earnings, the schemes require a consistent flow of money from new investors to continue. Ponzi schemes tend to collapse when it becomes difficult to recruit new investors or when a large number of investors ask to cash out.
What is a Ponzi scheme?
A Ponzi scheme is an investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors. Ponzi scheme organizers often solicit new investors by promising to invest funds in opportunities claimed to generate high returns with little or no risk. In many Ponzi schemes, the fraudsters focus on attracting new money to make promised payments to earlier-stage investors and to use for personal expenses, instead of engaging in any legitimate investment activity.
SEC Charges Italian Company and Dutch Subsidiary in Scheme Bribing Nigerian Officials With Carloads of Cash
ENI and Snamprogetti to Pay $365 Million to Settle FCPA Violations
FOR IMMEDIATE RELEASE
2010-119
Washington, D.C., July 7, 2010 — The Securities and Exchange Commission today charged Italian company ENI, S.p.A. and its former Dutch subsidiary Snamprogetti Netherlands B.V. with multiple violations of the Foreign Corrupt Practices Act (FCPA) in a bribery scheme that included deliveries of cash-filled briefcases and vehicles to Nigerian government officials to win construction contracts.
Snamprogetti and ENI will jointly pay $125 million to settle the SEC's charges, and Snamprogetti will pay an additional $240 million penalty to settle separate criminal proceedings announced today by the U.S. Department of Justice.
Additional Materials
* Litigation Release No. 21588
* SEC Complaint
ENI and Snamprogetti are the latest to be charged in the decade-long Nigerian bribery scheme conducted by a joint venture of companies that also included Technip and KBR, Inc., both named in previous SEC enforcement actions. Technip, KBR and its former parent Halliburton Company paid a combined $917 million to settle FCPA charges. The $365 million to be paid by ENI and Snamprogetti brings the total sanctions against the companies involved in the scheme to more than $1.28 billion.
According to the SEC's complaint against ENI and Snamprogetti, filed today in federal district court in Houston, senior executives at Snamprogetti and the other joint venture companies authorized the hiring of two agents, a U.K. solicitor and a Japanese trading company, through which more than $180 million in bribes were funneled to Nigerian government officials to obtain several contracts to build liquefied natural gas (LNG) facilities on Bonny Island, Nigeria. The Nigerian government exercised majority control over the company that awarded the contracts — Nigeria LNG Ltd.
"This elaborate bribery scheme featured sham intermediaries, Swiss bank accounts, and carloads of cash as everyone involved made a concerted effort to cover their tracks," said Robert Khuzami, Director of the SEC's Division of Enforcement. "But the billion-plus dollars in sanctions paid by these companies show that ultimately there is no hiding or profiting from bribery."
Antonia Chion, Associate Director of the SEC's Division of Enforcement, added, "In the three settlements, the joint venture companies disgorge their $400 million in profits from the illicit contracts, the largest combined disgorgement amount ever in an FCPA violation."
The SEC's complaint alleges that senior sales executives at the joint venture companies formed a "cultural committee" to consider how to implement and hide the bribery scheme through sham consulting and services contracts with subcontractors or vendors. After Nigeria LNG awarded the joint venture companies a $2.2 billion LNG-related construction contract in December 1995, the companies sent a total of $60 million to the U.K. agent's Swiss bank account over the next 52 months. The U.K. agent transferred the money to accounts owned or controlled by high-ranking Nigerian government officials.
The SEC alleges that following a change in Nigerian government in 1999, representatives from the joint venture companies traveled to Nigeria to meet a high-ranking government official to continue the scheme. The official confirmed that the U.K. agent was the correct intermediary, and also appointed his own representative to negotiate the bribe amount. A senior officer from Snamprogetti and others from the joint venture met with the Nigerian official's representative in London and negotiated an amount of $32.5 million to be delivered through the U.K. agent. Days after the London meeting, Nigeria LNG awarded a contract to the joint venture companies for $1.2 billion.
The SEC alleges that in 2002 and 2003, the U.K. agent used a subcontractor on the Nigeria LNG project to transfer millions of dollars to a Nigerian government official for the benefit of a Nigerian political party. The subcontractor personally hand-delivered U.S. cash in briefcases to the Nigerian official in a hotel room in Abuja, Nigeria. The subcontractor also delivered the bribes to the Nigerian official in local Nigerian currency, the Naira. In these instances, because the Naira was too bulky to deliver by hand, the cash was loaded into a vehicle for delivery to the Nigerian official.
The SEC's complaint also alleges that ENI failed to ensure that its former subsidiary, Snamprogetti, complied with ENI's internal controls concerning the use of agents, and that the books and records of both companies were falsified as a result of the bribery scheme. After ENI became a U.S. issuer in 1995, it became subject to the FCPA, including the requirement to create and maintain adequate internal controls.
Without admitting or denying the SEC's allegations, Snamprogetti has consented to the entry of a court order permanently enjoining it from violating the anti-bribery and recordkeeping and internal controls provisions in Sections 30A and 13(b)(5) of the Securities Exchange Act of 1934 and Rule 13b2-1, and ENI has consented to the entry of a court order permanently enjoining it from violating the recordkeeping and internal controls provisions in Sections 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act. Snamprogetti and ENI also consented to the entry of court orders that require them, jointly and severally, to pay $125 million in disgorgement. The proposed settlements are subject to court approval.
In the related criminal proceeding announced today, the U.S. Department of Justice filed a criminal action against Snamprogetti, charging one count of conspiring to violate the FCPA and one count of aiding and abetting violations of the anti-bribery provisions of the FCPA. Snamprogetti has entered into a deferred prosecution agreement with the DOJ and agreed to pay a criminal penalty of $240 million.
The SEC's investigation was conducted by Kara Brockmeyer, Robert Wilson, Ansu Banerjee, and Stanley Cichinski. The SEC acknowledges the assistance of the U.S. Department of Justice, Fraud Section; the Federal Bureau of Investigation; and foreign authorities in Europe, Asia, Africa and the Americas.
# # #
For more information about this enforcement action, contact:
Antonia Chion
Associate Director, SEC Division of Enforcement
(202) 551-4842
http://www.sec.gov/news/press/2010/2010-119.htm
SEC to Publish for Public Comment Proposed Rules Expanding Stock-by-Stock Circuit Breakers
FOR IMMEDIATE RELEASE
2010-117
Washington, D.C., June 30, 2010 — The Securities and Exchange Commission today is publishing for public comment proposals by the national securities exchanges and FINRA to expand a recently adopted circuit breaker program to include all stocks in the Russell 1000 Index and certain exchange-traded funds.
The circuit breaker program was approved earlier this month in response to the market disruption of May 6 and currently applies to stocks listed in the S&P 500 Index. Trading in a security included in the program is paused for a five-minute period if the security experiences a 10 percent price change over the preceding five minutes. The pause gives the markets an opportunity to attract new trading interest in an affected stock, establish a reasonable market price, and resume trading in a fair and orderly fashion. The circuit breaker program is in effect on a pilot basis through Dec. 10, 2010.
"The proposals would expand the uniform circuit breakers to many more stocks and ETFs," said SEC Chairman Mary Schapiro. "We look forward to receiving comments from the public on the proposed addition of the Russell 1000 Index securities and the selected exchange-traded funds to the circuit breakers."
A list of the securities included in the Russell 1000 Index, which was rebalanced on June 25, is available on the Russell website. The exchange-traded funds included in the proposal will be available on the SEC's website along with the proposed rule changes under Exhibit 3 to each filing.
The circuit breaker pilot program was developed after Chairman Schapiro convened a meeting of exchange leaders and FINRA at the SEC immediately following the May 6 market disruption. The markets will continue to use the pilot period to make appropriate adjustments to the parameters or operation of the circuit breakers as warranted based on their experience. "It is my hope to continue to expand the program to additional publicly traded companies," added Chairman Schapiro.
At Chairman Schapiro's request, the SEC staff is also:
* Considering ways to address the risks of different order types and their potential to contribute to sudden price moves.
* Considering steps to deter or prohibit the use by market makers of "stub" quotes, which are not intended to indicate actual trading interest.
* Studying the impact of other trading protocols at the exchanges, including the use of trading pauses and self-help rules.
* Continuing to work with the exchanges and FINRA to improve the process for breaking erroneous trades, by assuring consistency across markets.
The SEC staff also is working with the markets to consider recalibrating market-wide circuit breakers currently on the books — none of which was triggered on May 6. These circuit breakers apply across all equity trading venues and the futures markets.
Once the proposals have been published in the Federal Register, the public will have 10 days to submit comments.
# # #
http://www.sec.gov/news/press/2010/2010-117.htm
SEC Adopts New Measures to Curtail Pay to Play Practices by Investment Advisers
FOR IMMEDIATE RELEASE
2010-116
Video: Open Meeting
Play video of SEC Chairman Schapiro discussing new prohibitions on "pay to play" practices
Chairman Schapiro Discusses New Prohibitions on "Pay to Play" Practices:
Windows Media Player
QuickTime Text of
Chairman's statement
Washington, D.C., June 30, 2010 — The Securities and Exchange Commission today voted unanimously to approve new rules to significantly curtail the corrupting influence of "pay to play" practices by investment advisers.
Pay to play is the practice of making campaign contributions and related payments to elected officials in order to influence the awarding of lucrative contracts for the management of public pension plan assets and similar government investment accounts. The rule adopted by the SEC today includes prohibitions intended to capture not only direct political contributions by investment advisers, but also other ways that advisers may engage in pay to play arrangements.
"The selection of investment advisers to manage public plans should be based on the best interests of the plans and their beneficiaries, not kickbacks and favors," said SEC Chairman Mary L. Schapiro. "These new rules will help level the playing field, allowing advisers of all sizes to compete for government contracts based on investment skill and quality of service."
The new SEC rule has three key elements:
*
It prohibits an investment adviser from providing advisory services for compensation — either directly or through a pooled investment vehicle — for two years, if the adviser or certain of its executives or employees make a political contribution to an elected official who is in a position to influence the selection of the adviser.
*
It prohibits an advisory firm and certain executives and employees from soliciting or coordinating campaign contributions from others — a practice referred to as "bundling" — for an elected official who is in a position to influence the selection of the adviser. It also prohibits solicitation and coordination of payments to political parties in the state or locality where the adviser is seeking business.
*
It prohibits an adviser from paying a third party, such as a solicitor or placement agent, to solicit a government client on behalf of the investment adviser, unless that third party is an SEC-registered investment adviser or broker-dealer subject to similar pay to play restrictions.
The new rule becomes effective 60 days after its publication in the Federal Register. Compliance with the rule's provisions generally will be required within six months of the effective date. Compliance with the third-party ban and those provisions applicable to advisers to registered investment companies subject to the rule will be required one year after the effective date.
# # #
FACT SHEET
Across the country, state and local governments manage money as part of many important public programs. Such programs include public pension plans that pay retirement benefits to government employees, retirement plans in which teachers and other government employees can invest money for their retirement, and plans that allow families to invest money for college (commonly known as "529 plans").
The assets overseen by these governments are substantial. Public pension plans alone hold more than $2.6 trillion of assets and represent one-third of all U.S. pension assets. 529 plans today hold approximately $100 billion in assets.
The Role of an Investment Adviser
To help manage this money, state and local governments often hire outside investment advisers. These investment advisers may directly manage the money in the pension funds or government programs for these state and local governments.
In some cases, these advisers may provide advice to the governments about which investments they should make, or which investment options they should make available as choices to workers investing for retirement or families investing for college. Additionally, the advisers may manage the mutual funds or other investments in which employees' or families' money is invested.
In return for their advice, the investment advisers typically charge the governments fees that come out of the assets of the pension funds for which the advice is provided. If the advisers manage mutual funds or other investments that are options in a plan, the advisers receive fees from the money in those investments.
Selecting an Investment Adviser
The investment advisers are often selected by one or more trustees who are either themselves elected officials, or are appointed by elected officials. While such a selection process is common, the fairness of the selection process can be undermined in two ways.
On the one hand, the process can be undermined when advisers seeking to do business with state and local governments make political contributions to elected officials or candidates, hoping to influence the selection process. On the other hand, elected officials or their associates may ask advisers for political contributions, or otherwise foster a perception that only advisers who make contributions will be considered for selection. Hence the term: "pay to play."
In recent years, the SEC has charged investment advisers with engaging in pay to play practices. Investment advisers who engage in such practices compromise their obligations to put their clients' interests first. Pay to play practices distort the process by which investment advisers are selected and can harm the pension, retirement or 529 plans, which may receive inferior advisory services and pay higher fees. Pay to play practices also create an uneven playing field among investment advisers, and may hurt smaller advisers who cannot afford the required contributions.
Prohibitions of the Pay to Play Rule
Advisers and government officials engaging in pay to play practices may try to hide the true purpose of contributions or payments. The SEC today adopted a rule that includes prohibitions intended to capture not only direct political contributions by advisers, but other ways advisers may engage in pay to play arrangements.
Restricting Political Contributions
Under the new rule, an investment adviser who makes a political contribution to an elected official in a position to influence the selection of the adviser would be barred for two years from providing advisory services for compensation, either directly or through a fund.
The rule applies to the investment adviser as well as certain executives and employees of the adviser. Additionally, the rule applies to political incumbents as well as to candidates for a position that can influence the selection of an adviser.
There is a de minimis provision that permits an executive or employee to make contributions of up to $350 per election per candidate if the contributor is entitled to vote for the candidate, and up to $150 per election per candidate if the contributor is not entitled to vote for the candidate.
Banning Solicitation of Contributions
The pay to play rule prohibits an adviser and certain of its executives and employees from asking another person or political action committee (PAC) to:
1.
Make a contribution to an elected official (or candidate for the official's position) who can influence the selection of the adviser.
2.
Make a payment to a political party of the state or locality where the adviser is seeking to provide advisory services to the government.
Banning Certain Third-Party Solicitors
The pay to play rule also prohibits an adviser and certain of its executives and employees from paying a third party, such as a solicitor or placement agent, to solicit a government client on behalf of the investment adviser, unless that third party is an SEC-registered investment adviser or broker-dealer subject to similar pay to play restrictions.
Restricting Indirect Contributions and Solicitations
Finally, the pay to play rule would prohibit an adviser and certain of its executives and employees from engaging in pay to play conduct indirectly, such as by directing or funding contributions through third parties such as spouses, lawyers or companies affiliated with the adviser, if that conduct would violate the rule if the adviser did it directly. This provision prevents advisers from circumventing the rule by directing or funding contributions through third parties.
http://www.sec.gov/news/press/2010/2010-116.htm
SEC Charges California Telecommunications Company With FCPA Violations
FOR IMMEDIATE RELEASE
2010-115
Washington, D.C., June 29, 2010 — The Securities and Exchange Commission today filed a settled federal court action against San Jose, Calif.-based telecommunications company Veraz Networks, Inc., alleging that Veraz violated the books and records and internal controls provisions of the Foreign Corrupt Practices Act (FCPA). The alleged violations stemmed from improper payments made by Veraz to foreign officials in China and Vietnam after the company went public in 2007.
The SEC alleges that Veraz engaged a consultant in China who in 2007 and 2008 gave gifts and offered improper payment together valued at approximately $40,000 to officials at a government controlled telecommunications company in China in an attempt to win business for Veraz. A Veraz supervisor who approved the gifts described them in an internal Veraz email as the "gift scheme." Similarly in 2007 and 2008, the SEC alleges that a Veraz employee made improper payments to the CEO of a government controlled telecommunications company in Vietnam to win business for Veraz.
Additional Materials
* Litigation Release No. 21581
* SEC Complaint
"It is particularly important that newly public companies doing business overseas establish the appropriate policies and procedures to prevent a culture of payment to foreign officials from developing," said Marc J. Fagel, Regional Director of the Commission's San Francisco Regional Office.
According to the SEC's complaint, filed in U.S. District Court for the Northern District of California, Veraz violated the books and records and internal controls provisions of the FCPA by failing to accurately record the improper payments on its books and records, and failing to devise and maintain a system of effective internal controls to prevent such payments. Veraz, without admitting or denying the allegations in the Commission's complaint, consented to the entry of a final judgment permanently enjoining Veraz from future violations of Sections 13(b)(2)(A) and 13(b)(2)(B) of the Securities Exchange Act of 1934 and ordering Veraz to pay a penalty of $300,000.
This case was investigated by Monique C. Winkler, Robert S. Leach, and Cary Robnett of the San Francisco Regional Office.
The Commission would like to thank the U.S. Department of Homeland Security for its assistance in this matter.
# # #
For more information about this enforcement action, contact:
Marc Fagel
Director, SEC San Francisco Regional Office
415-705-2449
Michael Dicke
Associate Director, SEC San Francisco Regional Office
415-705-2458
http://www.sec.gov/news/press/2010/2010-115.htm
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Modified: 06/29/201
SEC Charges Two Canadians With Fraudulently Touting Penny Stocks on a Website, Facebook and Twitter
FOR IMMEDIATE RELEASE
2010-114
Washington, D.C., June 29, 2010 — The Securities and Exchange Commission announced today that it has obtained an emergency asset freeze against a Canadian couple who fraudulently touted penny stocks through their website, Facebook and Twitter. The SEC also charged two companies the couple control and obtained an asset freeze against them.
According to the SEC's complaint, the defendants profited by selling penny stocks at or around the same time that they were touting them on www.pennystockchaser.com. The website invites investors to sign up for daily stock alerts through email, text messages, Facebook and Twitter.
Additional Materials
* Litigation Release No. 21580
* SEC Complaint
The SEC alleges that since at least April 2009, Carol McKeown and Daniel F. Ryan, a couple residing in Montreal, Canada, have touted U.S. microcap companies. According to the SEC's complaint, McKeown and Ryan received millions of shares of touted companies through their two corporations, defendants Downshire Capital Inc., and Meadow Vista Financial Corp., as compensation for their touting. McKeown and Ryan sold the shares on the open market while PennyStockChaser simultaneously predicted massive price increases for the issuers, a practice known as "scalping."
"As alleged in our complaint, McKeown and Ryan used all the modern methods to communicate with investors including the PennyStockChaser website, e-mail, text messages, Facebook, and Twitter yet failed to adequately communicate that their rosy predictions for touted stocks were accompanied by their sales of those very same stocks." said Eric I. Bustillo, Director of the SEC's Miami Regional Office.
The SEC's complaint, filed in the U.S. District Court for the Southern District of Florida, also alleges McKeown, Ryan and one of their corporations failed to disclose the full amount of the compensation they received for touting stocks on PennyStockChaser. The SEC alleges that McKeown, Ryan and their corporations have realized at least $2.4 million in sales proceeds from their scalping scheme.
The SEC's complaint charges McKeown, Ryan, Downshire Capital Inc. and Meadow Vista Financial Corp. with violating Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5 thereunder. The SEC's complaint also charges McKeown, Ryan and Meadow Vista Financial Corp. with violating Section 17(b) of the Securities Act of 1933. In addition to the emergency relief already granted by the U.S. District Court the Commission also seeks a preliminary injunction and permanent injunction, along with disgorgement of ill-gotten gains plus prejudgment interest and the imposition of a financial penalty, penny stock bars against the individuals and the repatriation of assets to the United States.
In the course of its investigation, the SEC worked with the Quebec Autorité des marchés financiers (AMF), which was also investigating this matter. As a result of both ongoing investigations, the AMF obtained an emergency order freezing assets and a cease trade order against McKeown, Ryan, Downshire Capital Inc. and Meadow Vista Financial Corp. The SEC appreciates the collaboration with the AMF.
The SEC's case was investigated by Michael L. Riedlinger, Timothy J. Galdencio and Eric R. Busto of the Miami Regional Office. The SEC's litigation effort will be led by Christine Nestor, Amie R. Berlin and Robert K. Levenson. The SEC's investigation is continuing.
# # #
For more information regarding this enforcement action, contact:
Eric I. Bustillo
Regional Director, SEC's Miami Regional Office
(305) 982-6300
Glenn S. Gordon
Associate Regional Director, SEC's Miami Regional Office
(305) 982-6300
http://www.sec.gov/news/press/2010/2010-114.htm
Chairman Schapiro Statement on Regulatory Reform Legislation
FOR IMMEDIATE RELEASE
2010-113
Washington, D.C., June 28, 2010 — The following is a statement from SEC Chairman Mary L. Schapiro regarding legislation to be considered this week by the Congress:
"On Friday, Congress took a giant step toward achieving important comprehensive financial regulatory reform.
"The bill that emerged from the conference to be considered this week will improve oversight of large interconnected institutions, fill significant regulatory gaps, provide greater oversight and transparency over hedge funds and over-the-counter derivatives, improve the SEC's funding process and provide additional investor protections."
# # #
http://www.sec.gov/news/press/2010/2010-113.htm
SEC Halts $105 Million Ponzi Scheme by U.S. Virgin Islands-Based Money Manager
FOR IMMEDIATE RELEASE
2010-112
Washington, D.C., June 28, 2010 — The Securities and Exchange Commission today announced fraud charges and an emergency asset freeze against a purported fund manager based in the U.S. Virgin Islands who perpetrated a $105 million Ponzi scheme against investors.
Additional Materials
* Litigation Release No. 21579
* SEC Complaint
The SEC alleges that Daniel Spitzer, a resident of St. Thomas, used several entities and sales agents to misrepresent to investors that their money would be invested in investment funds that, in turn, would be invested primarily in foreign currency. Investors were falsely told that Spitzer’s funds had never lost money and historically produced profitable annual returns that one year reached over 180 percent. Spitzer instead used money raised from new investors to pay earlier investors, and misappropriated investor funds to pay unrelated business expenses. He concealed his scheme by issuing phony documents to investors that led them to believe their investments were profiting.
The SEC has obtained an emergency court order freezing the assets of Spitzer and his companies.
“Daniel Spitzer ran an elaborate Ponzi scheme that he disguised by moving investor money through a complex network of foreign bank and brokerage accounts,” said Merri Jo Gillette, Director of the SEC’s Chicago Regional Office. “He deceived investors into believing that he was using a sophisticated investment strategy that didn’t really exist.”
According to the SEC’s complaint, filed in U.S. District Court for the Northern District of Illinois, Spitzer conducted his fraudulent scheme, which involved 400 investors, from at least 2004 to present. He only invested approximately $30 million of the more than $105 million he raised from investors. Of that amount, Spitzer used approximately $13.5 million to invest through an offshore entity via a bank account in the Netherlands Antilles. These investments, some of which were placed in a French financial institution, lost money and were subsequently liquidated. Spitzer used another $16 million to invest in money market funds that earned only a few thousand dollars. Spitzer liquidated these investments as well. After the investments were liquidated, the money was returned to Spitzer, and he used it to repay investors in Ponzi-like fashion. To cover up his scheme, Spitzer issued to his investors false Schedule K-1s that showed inflated returns and led them to believe that their investments were profitable.
The SEC’s complaint alleges that Spitzer used offshore bank accounts to pay purported business expenses of his companies. Spitzer deposited investor funds into bank accounts at the National Bank of Anguilla and the First Bank of Puerto Rico, from which he paid more than $15 million in purported operating expenses and payments to himself and various sales agents. Spitzer also used more than $4.8 million to pay third-party business expenses. The SEC further alleges that Spitzer led an extravagant lifestyle and spent more than $900,000 at a Las Vegas casino.
According to the SEC’s complaint, Spitzer’s scheme is on the verge of collapse as he has attempted to delay and avoid paying investor redemptions. As recently as March 2010, Spitzer obtained $100,000 from an investor for an investment in one of his purportedly more conservative investment funds. Rather than invest the money, Spitzer used a portion of the money in April 2010 to pay other investors and third-party expenses.
At the SEC’s request for emergency relief for investors, the Hon. Harry D. Leinenweber of the U.S. District Court for the Northern District of Illinois issued an order freezing all assets of Spitzer and his companies. Among other things, the court order requires that the defendants repatriate to the U.S. all assets located overseas.
The SEC’s complaint charges Spitzer and the defendant entities with violations of Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. The complaint also charges Spitzer and two of the asset management companies with violations of Section 206(1), 206(2) and 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-8 thereunder. The complaint also seeks a court order of permanent injunction against Spitzer and each of the defendant entities, as well as an order of disgorgement including prejudgment interest. The complaint also seeks financial penalties against Spitzer and five of the asset management companies.
The SEC’s investigation was conducted by Natalie G. Garner, Wilburn Saylor, James G. Lundy, Andrew P. O’Brien, Barry Isenman and Peter K.M. Chan of the Chicago Regional Office. The SEC acknowledges the assistance of the Commodity Futures Trading Commission, Irish Financial Regulator, Danish Financial Supervisory Authority, Autorité des marches financier in France, the Ontario Securities Commission and the Financial Intelligence and Investigations Unit Attached to the Royal Anguilla Police Force in Anguilla.
The SEC’s investigation is continuing. Investors with questions or information about this matter may call the SEC’s Chicago Regional Office’s telephone line dedicated to the case at (312) 353-0626.
# # #
For more information about this enforcement action, contact:
Timothy L. Warren
Associate Regional Director, SEC’s Chicago Regional Office
(312) 353-7394
Peter K.M. Chan
Assistant Regional Director, SEC’s Chicago Regional Office
(312) 353-7410
Barry Isenman
Assistant Regional Director, SEC’s Chicago Regional Office
(312) 886-8515
http://www.sec.gov/news/press/2010/2010-112.htm
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Here is a Board where you can Pass Information on MM Manipulation on your Stocks. The Goal will be to gather enough Factual information to Present to the SEC, Congress and whoever else may listen. We need to protect GOOD American Business.
This board is a Place to fight SHARE PRINTERS !!
EVERYTHING SAID IS OF PURE OPINION ON THIS BOARD>> FOLLOW AT YOUR OWN RISK!!!!!
We also want to warn others about "CEO's" or "IR Firms" who do nothing but DILUTE Stocks for there own Gain !
Members: Officers / CEO's / Presidents / CFO's / Directors / Consultants / Treasurer
Anthony Welch | Milton.Ault | Joe Overcash | W.Smart | Edward.Vasker |
Carlton Wingett | M.Zoyes | A.Parsinia | Christopher Davies | JC Barbeck |
Paul Crawford | Khoo.Hua | K Yeung | Don Paradiso | F.Neukomm |
Stanley Larson | Merlin Larson | Troy Lyndon | K.Eade | Daniel McCormick |
Dennis Atkins | Richard Knox |
Robert Thayer | Dale Geck | Chris Glover | Ricardo Caicedo | K.A. Anderson |
IR FIRMS (BEWARE when you see these IR Firms listed on a stock)
Mani Mor Poo | VUFinancial (Vinci's) | Yorkville Advisors |
Big Apple Consulting more on them HERE | Boost Marketing | |
TRANSFER AGENCIES (Carefull when you see these "Transfer Agents" listed on a stock)
Transfer Online ( L.Livingston) | ||
Information about TOXIC Financing is needed also !!
Definitions
PRE 14C All preliminary information statements, excluding, mergers, contested solicitations and special meetings.
DEF 14C All types of definitive statements, excluding: mergers or acquisitions, contested solicitations and special meetings.
Reg D Companies selling securities in reliance on a Regulation D exemption or a Section 4(6) exemption from the registration provisions of the '33 Act must file a Form D as notice of such a sale. The form must be filed no later than 15 days after the first sale. The exact form type is usually REGDEX, but may be a REG D-1 or similar.
SB-2 This form may be used by "small business issuers" to register securities to be sold for cash.
S-8 This form is used for the registration of securities to be offered to an issuer's employees pursuant to certain plans.
S-1 This is the basic registration form. It can be used to register securities for which no other form is authorized or prescribed, except securities of foreign governments or political sub-divisions thereof.
1-E / 2-E Business development companies (BDC) can avail themselves of a more esoteric provision of the Securities Act - Regulation E, which provides an exemption from registration for securities issued by BDCs. In short, under Regulation E, a BDC may issue up to $5 million worth of securities a year without registration. Also under Regulation E, an individual may offer to sell up to $100,000 of securities in a BDC each year.
424B1, 2, 3, and 4 filings are final registration statements to register stock under previously filed SB-2 S-1 and S-2 filings, and they serve other purposes.
EFFECT filings are notice's of effectiveness of POS AM's and some S filings ie: S-1, SB-2. The EFFECT filing comes prior to the 424B3 filing we see when the shares enter the market.
ALL the posts here are OPINIONS and in no way are given as Investment Advice
GOOD DD BOARDS
DD Support Board and Fraud Research Team
Reverse Split Repeat Offenders (RS/RO)
http://investorshub.advfn.com/boards/board.asp?board_id=3017
Breaking Stock-Related News
http://investorshub.advfn.com/boards/Board.asp?Board_ID=1508
Here's a link that alerts name changes/RS's: http://www.otcbb.com/dailylist/
Here's a link to search SOS(secretary of state) filings(this will help you locate how many shares a company is authorized to issue-find out where the company is incorporated and search under "business entity name": http://www.coordinatedlegal.com/SecretaryOfState.html
Here's a board that has most of the TRANSFER AGENTS contact info-some are cooperative, and some are "gagged"(they won't release share info): http://investorshub.advfn.com/boards/board.aspx?board_id=10067
Investing Scams: 10 Tell-All Questions
Wednesday December 31, 8:54 am ET
By Motley Fool Staff
With Bernie Madoff's Ponzi scheme foremost in many investors' minds, how can you tell whether an investment pitch is a scam? Here are 10 tell-all questions to consider:
1. Does it promise "low risk and high gain?"
Click your heels three times and repeat to yourself, "There is no such thing as a free lunch." It's a fundamental fact of investing that the higher the potential return, the greater the risk that you may never see that return.
2. Will it be "too late" if you don't act now?
Why will it be too late? Any legitimate investment will be there tomorrow, and next week, and next year. Never be pressured into investing in something because tomorrow might be too late. Even if it turns out that the stock doubles tomorrow, you should feel better knowing that you were cautious and responsible with your money. Besides, if someone's giving you a "hot inside tip," you've got a lot more to worry about than whether or not you should act quickly. (See question 10.)
3. Does it claim to predict the future?
"It will double in three months." Oh, yeah? And where did your broker buy his or her crystal ball? Not only is this a ridiculous promise for a broker to make, it's illegal. Report this infraction to his or her sales manager (the next caller might not be as smart as you). And if the matter doesn't get satisfactory attention from a supervisor, contact the Financial Industry Regulatory Agency (FINRA) at www.finra.org.
4. What is the background of the salesperson and his/her employer?
Any individual selling securities to the public must pass a background check, a series of examinations, and be registered with FINRA. Likewise, their employers must also be known to FINRA and the SEC. If you would like to check up on the background of your broker or brokerage firm, use FINRA's BrokerCheck page. But remember, even if they don't have any complaints against them, it doesn't necessarily mean they can be trusted. You could be "Scamee No. 1."
5. Does it "guarantee" anything?
It is not only impossible to guarantee any rate of performance, but doing so will also get your broker tossed out of the industry.
6. Has the salesperson offered to reimburse you for any losses you might incur?
One more no-no that your broker isn't supposed to promise you. This one can get him or her booted, too.
7. Are you one of the "lucky few who have been chosen" to invest in XYZ company?
While this may make you feel special, don't fall for it. You just happen to be one of the lucky few who answered the phone.
8. Does the salesperson claim to have personally invested in the company, too?
What difference does it make whether he or she made a bad investment too? Do you trust the salesperson to call you if and when the investment goes sour? And will he or she get out first?
9. Is the salesperson unwilling to supply a prospectus or financial statements?
If a new company is just going public (an IPO, which stands for initial public offering), you must be given a prospectus. It is long and written in legalese and printed on very thin paper that you can barely read. Read it anyway. Especially the part called "Risks to Investors." If the company in question has been around awhile, ask to see the financial statements for the past two years.
10. Is the salesperson's information "a hot inside tip?"
This is especially important to pay attention to -- not because it could make you rich, but because it could land you in jail. It is illegal to pass on or act on material that is inside information. Anyone telling you otherwise is a liar.
http://biz.yahoo.com/fool/081231/rx12041.html?.v=2&printer=1
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some links that will help in DD
http://investor.gov/ponzi-schemes/
http://investor.gov/avoid-fraud/
http://www.otcmarkets.com/index.jsp
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