Unless they circumvented the Reg Sho rules then yes.
As these people did.
y Carol S. Remond
A Dow Jones Newswires Column
Struggling Internet retailer Overstock.com Inc. (OSTK) just got some new
ammunition in its quixotic fight against short-sellers, those investors who bet
against a company.
Turns out that one guy did, in fact, illegally trade shares of the company
sometimes between August and December 2005. Some details about those trades
surfaced Tuesday in an American Stock Exchange's disciplinary decision against
Scott Arenstein and his options trading firm, SBA Trading LLC.
While SBA's improper trading doesn't come close to amount to the massive
conspiracy alleged by Overstock, it's likely that Chief Executive Patrick Byrne
and his lawyers will use the information to continue building their case against
short sellers and brokerage firms through which they trade.
Arenstein and SBA, without admitting or denying liability, agreed to disgorge
$1.4 million in trading profits and pay a $3.6 million fine. Arenstein also
consented to a five-year ban.
Overstock isn't named in the regulatory decision against Arenstein and SBA,
but an example of their trading activities included in the document provides
tantalizing clues that company ABCD with Dec 45 calls at $3.70, Dec 45 puts at
$6.40 and a stock price of $43.70 a share is in fact Salt Lake City-based
Overstock.
Arenstein's brother Brian Arenstein and his firm ALA Trading LLC also
separately settled, without admitting or denying liability, similar charges and
agreed to disgorge $1.8 million in trading profits and pay a $1.2 million fine
for trading between Nov. 16 and Dec. 17, 2006. Brian Arenstein also agreed to a
five-year ban. In Brian's case, the example provided by AMEX indicates that he
was improperly selling short NYSE Euronext (NYX).
A lawyer for the Arensteins declined to comment. Those were the largest fines
ever levied by AMEX. AMEX said in a press release that the improper trading was
detected and investigated by the Financial Industry Regulatory Authority, or
FINRA.
AMEX found that the Arensteins and their firms violated the so-called Reg SHO,
a regulation enacted by the U.S. Securities and Exchange Commission in 2005 to
modernize short-selling rules and address failures to deliver stock on
settlement date. The firms had no customer and only traded for their own
accounts.
Under Reg SHO, exchanges provide daily lists of securities with large amounts
of failure to deliver. Once a security gets on one of these threshold lists, it
becomes harder and more expansive to short the stock. The SEC recently decided
to strengthen its rules by doing away with a clause that "grandfathered"
pre-existing failures to deliver into the system.
The SEC is also considering eliminating some exemptions contained in Reg SHO,
including one that allows options market makers providing liquidity to the
market to avoid having to locate stock prior to selling the underlying equity
short.
The regulatory decisions against Scott and Brian Arenstein show that they
failed to meet requirements to be classified as a market maker. In both cases,
AMEX found that the Arensteins and their firms effected a number of complex
synthetic transactions to circumvent the delivery requirements of Reg SHO. The
exchange found that to avoid buy-ins that would have forced them to close out
transactions after they failed to deliver stock on time, the firms executed
one-day Flex option transactions, in effect resetting the clock on their failed
trades.
In a short sale, a security not owned by the seller is sold in anticipation of
a decrease in the stock price. Under Reg SHO, brokers who fail to deliver a
security for 13 consecutive settlement days have to execute mandatory buy-in to
clean the fails.
Overstock is one of a handful of companies under regulatory scrutiny that over
the last two years have launched massive legal and public relations campaigns
against bearish hedge funds and research firms. Overstock's CEO Byrne claims
that the entire financial system is bent against his company and others and that
failures to deliver are so pervasive that the entire system is in danger of
collapsing. While acknowledging that failures to deliver must be addressed and
cleaned up, securities regulators insist that the problem is minimal.
Byrne started a very vocal crusade against short sellers in late 2004 after
his company's performance and stock price started to take a turn for the worse.
The SEC began an informal inquiry into Overstock in 2005. The Commission also
looked into Overstock's claims that its stock price had been manipulated by
short sellers and a research firm called Gradient Analytics Inc. But the SEC
said in February that it had closed its probe into Gradient without bringing
charges against the Arizona research firm.
Meanwhile, a lawsuit brought by Overstock against hedge fund Rocker Partners
LP and Gradient is ongoing in California state court. The company is also suing
a group of brokerage firms in the Superior Court of California in San Francisco
County, alleging that the brokers participated in a massive illegal stock market
manipulation scheme involving illegal short selling.
Reg SHO's threshold lists gave investors a new criterion by which to gauge the
value of a company's stock when they first appeared in late 2004. Once a stock
gets on one of these lists, it becomes harder to borrow and short and resulting
forced buy-ins of short positions can lead to stock appreciation.
But those lists had a particularly drastic impact in the options market where
put options for hard to borrow stocks started trading at a premium to call
options because of higher borrowing costs and the risk of buy-ins.
In those two cases, Scott and Brian Arenstein were essentially trying to
capture that premium without baring any of the added risk.
A call option provides the holder the right to purchase the underlying stock
at a specified price, while a put option gives him the right to sell the stock
at a specified price.
(Carol S. Remond is an award-winning columnist who won a Gerald Loeb Award in
2005 for best news service content with "Exposing Small-Cap fraud," a series of
articles that described how three small companies unscrupulously pumped up their
stocks.)
-By Carol S. Remond, Dow Jones Newswires; 303-997-5783;
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