The Securities and Exchange Commission has charged a Chicago area options trader with violating short selling restrictions that netted him at least $1.5 million in ill gotten gains, SEC officials said Tuesday.

According to the SEC's order instituting administrative proceedings, Gary S. Bell, 51, of Naperville, Ill., violated the "locate" and "close out" requirements of SEC Regulation SHO that require market participants to locate a source of borrowable shares prior to selling short and to deliver those securities by a specified date.

Market makers who ensure liquidity in the market are exempt from these requirements if they are engaged in bonafide market-making activities in the security for which the exception is claimed.

The SEC's order claims that Bell created naked short sales from December 2006 to June 2007 while working as a broker-dealer himself and then later as the principal trader at Chicago-based broker-dealer GAS I LLC, which is no longer in business. The SEC says Bell and GAS engaged in two specific types of transactions that violated the locate and close-out requirements of the Regulation SHO.

The first type of transaction -- a "reverse conversion" or "reversal" -- involves selling stock short and simultaneously selling a put option and buying a call option on the stock. The second type of transaction is a combined stock-and-option transaction, essentially a sham to create the illusion that the party subject to a close-out obligation has satisfied that obligation by buying the same kind and quantity of securities it has sold short.

The SEC's order finds that Bell's and GAS's transactions created the false appearance of compliance with the requirements of Regulation SHO. The shares that were apparently purchased in the transactions were never actually delivered because they were purchased from a "naked" short seller, and left Bell and GAS with persistent "fail-to-deliver" positions, meaning that they did not deliver shares to make good on their sales of stock. The "market maker" exception to Regulation SHO was not available to either Bell or GAS because they were not engaging in bonafide market making activities in these securities. As a result of his short selling violations, Bell received ill-gotten gains of at least $1.5 million, the SEC alleges.

The SEC's order finds that Bell improperly relied on the market-maker exception in his line of business that essentially loaned large amounts of hard-to-borrow stock to broker-dealers, who then provided their customers with locates on those shares and lucrative stock loans of those shares. Customers then sold short certain securities that they may not have otherwise been able to without Bell's participation. However, because the stock being provided by Bell was not truly available for delivery to the broker-dealers or their short selling customers, Bell actually was creating illegal "naked" short sales.

George S. Canellos, director of the SEC's New York Regional Office, said Bell avoided the cost of borrowing shares while engaging in complex short selling transactions. "Thus he (Bell) earned significant profits with minimal risk and gained an advantage over legitimate participants in the market,'" he said.

Bell settled the SEC's administrative proceedings without admitting or denying the SEC's findings. Bell agreed to pay more than $2 million to settle the SEC's charges. The SEC also ordered Bell to avoid further securities law violations and suspends him from associating with any broker, dealer, investment advisor, municipal securities dealer, municipal advisor, transfer agent or nationally recognized statistical rating organization for a period of nine months.

Bell must also pay $1.5 million in disgorgement, $336,094 in prejudgment interest, and a $250,000 penalty.