SEC Charges Traders In 'Free-Riding' Scheme

The Securities and Exchange Commission today charged a pair of purported money managers with orchestrating an illegal "free-riding" scheme of selling stocks before they paid for them, resulting in over $2 million in losses to broker-dealers.

The SEC alleges that Scott Kupersmith, of Boca Raton, Fla., and Frederick Chelly, of Miami Beach, Fla., portrayed themselves to broker-dealers as money managers for hedge funds and private investors, and they opened brokerage accounts in the names of purported investment funds they created.

Kupersmith, 46, and Chelly, 42, then engaged in illegal free-riding by interchangeably buying and selling the same quantity of the same stock in different accounts-frequently on the same day. They made $600,000 in profits by playing off the daily swings in the stock prices, according to the SEC.

Kupersmith and Chelly didn't have sufficient securities or cash to cover the trades so they used proceeds from stock sales in one brokerage account to pay for the purchase of the same stock in another  account, according to the SEC.

The SEC alleges that Kupersmith and Chelly took trade profits, but when they faced substantial losses, they failed to cover their sales and left broker-dealers to settle the trades at a significant loss. In total, their brokers suffered more than $2 million in losing trades, according to the SEC.

"Kupersmith and Chelly engaged in a classic 'heads I win, tails you lose' scheme to trade risk-free at the expense of broker-dealers,'' said George S. Canellos, director of the SEC's New York Regional Office.

The SEC's complaint, filed in U.S. District Court in New Jersey, claims that Kupersmith and Chelly traded through a special type of cash account that broker-dealers offer with the understanding that the customer has sufficient securities and cash held with a third-party custodial bank to cover trades.

Kupersmith and Chelly never disclosed to broker-dealers that they were instead using proceeds from sales of shares in one brokerage account to pay for their purchase in another brokerage account, according to the SEC. They also used offshore accounts to facilitate their trading activity.

The SEC claims that Kupersmith and Chelly's scheme, started in May 2009, began to unravel in late 2010, when they failed to deliver shares to settle long sales in various brokerage accounts.

The complaint seeks a final judgment permanently enjoining the defendants from future violations of federal securities laws and ordering them to disgorge any ill-gotten gains, plus prejudgment interest, and pay financial penalties.

In parallel actions, the U.S. Attorney's Office for the District of New Jersey and the Manhattan District Attorney's Office today announced the unsealing of criminal charges against Kupersmith. The SEC said its investigation is ongoing.