The Securities and Exchange Commission (SEC) has charged Chicago-based online brokerage firm optionsXpress and five individuals for their alleged participation in an abusive naked short-selling scheme.
The SEC claims that between October 2008 and March 2010, the company officers and one customer orchestrated a scheme that involved a series of phony transactions, violating a regulation requiring that equity securities be delivered when due.
Charles Schwab Corp. bought optionsexpress on Sept. 1 for an estimated $1 billion. Charles Schwab already offers options trading through its discount brokerage, and bought optionsXpress to broaden its reach in the options trading market. As of last June, optionsXpress had 397,400 client accounts, $8.4 billion in client assets and a 12-month average of 44,900 daily revenue trades.
The SEC alleges that optionsXpress failed to satisfy its close-out obligations by repeatedly engaging in a series of sham "reset" transactions designed to give the illusion that the firm had purchased securities of like kind and quantity. The optionsXpress's former chief financial officer, Thomas E. Stern of Chicago, was named in the SEC's administrative proceeding along with customer Jonathan I. Feldman. Three other optionsXpress officials -- head of trading and customer service Peter J. Bottini and compliance officers Phillip J. Hoeh and Kevin E. Strine -- were named in a separate administrative proceeding and settled the charges against them.
Stephen Senderowitz, partner at Chicago-based law firm Winston & Strawn LLP, which is representing optionsXpress, said the SEC claims against optionsXpress and its executives are without merit and that all the trading activity occurred before Schwab acquired optionsXpress.
Senderowitz says that all optionsXpress trades were "arms length market transactions and there was a reasonable likelihood at all times that the rights would not be assigned," he said. "Our executives were in touch with various regulators during the course of this trading activity."
"We believe that the evidence at trial will demonstrate that optionsXpress timely covered the assignments consistent with SEC's SHO regulation, that there were no downward pressure on prices, that no one was defrauded, that the trades were not shams, that they had economic risk and economic purpose, and they were not 'novel' or 'exotic,'" Senderowitz said.
The SEC's regulation SHO requires the delivery of equity securities to a registered clearing agency when delivery is due, generally three days after the trade date. If no delivery is made, the firm must purchase or borrow the securities to close out the failure-to-deliver position by no later than the beginning of regular trading hours on the next day.
The SEC alleges that the sham reset transactions impacted the market for the issuers. Specifically, from Jan. 1, 2010 to Jan. 31, 2010, optionsXpress customers including Feldman accounted for an average of 47.9 percent of the daily trading volume in one of the securities. In 2009 alone, the optionsXpress customer accounts engaging in the activity purchased approximately $5.7 billion worth of securities and sold short approximately $4 billion of options. In 2009, Feldman himself purchased at least $2.9 billion of securities and sold short at least $1.7 billion of options through his account at optionsXpress, the SEC says.
"Feldman and optionsXpress used sham reset transactions to avoid, sometimes for months, compliance with the SEC's stock delivery requirements," said Robert Khuzami, director of the SEC's Division of Enforcement. "In effect, they 'kited' shares of stock, thus depriving buyers of the benefit of their bargain -- prompt delivery of their shares.
-Jim McConville