On Friday August 9, 2013, the Securities and Exchange Commission issued a Risk Alert to help market participants detect and prevent options trading that circumvents an SEC short sale rule.
The SEC’s Office of Compliance Inspections and Examinations (OCIE) issued the alert after its examiners observed options trading strategies that appeared to evade certain requirements of the short-sale rule. The alert describes and warns of the strategies used by some customers, broker-dealers and clearing firms, summarizes related enforcement actions, and makes suggestions regarding practices found to be effective in detecting and preventing trading intended to evade Regulation SHO.
Regulation SHO tightened requirements for short sales, which involve the selling of securities not already owned, usually by the borrowing of securities. Short sellers profit from price declines by replacing borrowed securities at a lower price. Under Regulation SHO, short sellers who fail to deliver securities after the settlement date are required to close out their position immediately, unless they qualify as a market maker. The trading strategies observed by the OCIE staff may give the impression of satisfying the Regulation SHO “closeout requirement,” while in effect evading it.
In addition, the Risk Alert describes activities that the staff has observed that may indicate an attempt to circumvent Regulation SHO. These include:
- Trading exclusively or excessively in hard-to-borrow securities or threshold list securities, or in near-term listed options on such securities
- Large short positions in hard-to-borrow securities or threshold list securities
- Large failure to deliver positions in an account, often in multiple securities
- Continuous failure to deliver positions
- Using buy-writes, married puts, or both, particularly deep in-the-money buy-writes or married puts, to satisfy the closeout requirement
- Using buy-writes with little to no open interest aside from that trader’s activity, resulting in all or nearly all of the call options being assigned
- Trading in customizable FLEX options in hard-to-borrow securities or threshold list securities, particularly very short-term FLEX options
- Purported market makers trading in hard-to-borrow or threshold list securities claiming the exception from the locate requirement of Regulation SHO; often these traders do not make markets in these securities, but instead make trades only to take advantage of the option mispricing
- Multiple large trades with the same trader acting as a contra-party in several hard-to-borrow or threshold list securities; often traders assist each other to avoid having to deliver shares
The text of the entire alert is available on the SEC website.
The Author
Laura Anthony, Esq.
Founding Partner
Legal & Compliance, LLC
Corporate, Securities and Going Public Attorneys
LAnthony@LegalAndCompliance.com
Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the OTC Market’s top source for industry news, and the producer and host of LawCast.com, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.
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