The Authoritative NSS Page

[Stock]

Uh oh, email:

Bottini, Hoeh, and Strine Knew or Should Have Known that the Trading was Problematic

16. On October 15, 2008, less than a month after the Commission issued its emergency order putting Rule 204T into effect, one of optionsXpress’ traders sent an internal email which described the trading: “the customer has short positions on hard to borrow stocks where the customer has to buy in every day. Our customer is buying back the short and writing in the money calls which are assigned on a daily basis.” Two weeks later, the firm’s Clearing Department raised concerns that the stock was not being bought in at market open. Strine replied back to the Clearing Department and the traders telling them: “According to the rules, they need to be closed out at the opening. The industry is pushing back on this, and requesting the [whole] day, but as it is now, we need to cover at the open.”

17. The following month, the Clearing Department informed Bottini of the “vicious cycle” that the buy-writes were causing: “Since we have an open CNS fail and as soon as we buy to cover, the customer shorts a call which gets assigned immediately, we are in a vicious cycle.”

18. In mid-November 2008, Bottini sent an email to the Clearing Department about an article in The Wall Street Journal describing the trading activity in the Arenstein cases and noting that FINRA had several cases involving this activity. Bottini wrote:

“There is an article in the WSJ about how short sellers in [Sears] are using options to circumvent the SEC cover rule. I think we need to review this.” The Clearing Department emailed back: “[The Customers are] definitely doing this.”

19. In July 2009, Bottini asked one of the exchanges for a fee modification for the buy-writes. As part of the request, Bottini noted that “[w]e do have some larger retail clients that have developed some ‘predictable’ strategies/behavior.” According to Bottini, the market makers using the exchange had begun to anticipate the buy-writes – meaning that the counterparties to the buy-writes were anticipating that the buy-writes would occur each day. Due to the fees, Bottini and optionsXpress worked to find another market for the buy-writes.

20. On August 5, 2009, the SEC instituted the Hazan and TJM settled actions, which were reviewed by Hoeh and Strine. Strine immediately recognized the similarities between the conduct in those actions and the Customers’ trading, but advised that there were distinguishing factors and the trading continued.

21. The following day, a trader at optionsXpress notified the Customers that “[ u ]nfortunately we will need to change how buy ins are covered. . . . This means once we get the buy in lists, the shares will need to be covered immediately in the morning. I apologize for this unfortunate change, but the SEC won’t budge on these rules.” In response to a question from one of the Customers, a trader at optionsXpress elaborated: “Compliance has also notified me that this could change further by having us place the covers in your account at the market, and have the customer place any option orders.” Nonetheless, and despite Strine’s advice in October 2008, optionsXpress was still not placing the buy-in orders at market open. In fact, optionsXpress did not consistently execute the buy-writes at or near market open.

http://www.sec.gov/litigation/admin/2012/34-66814.pdf