Today's reminder is directed at Wall Street traders - arranging for another trader at another firm to take your position for a few days, with an agreement to buy it back is illegal.
Traders have been doing this for years, and apparently the practice is so widespread that many traders do not give it a second thought - until the trade blows up. A few years ago I represented a trader who agreed to hold a position for a fellow trader over the end of the month. The friend needed to reduce his position for month end. The trader-friend asked my client to buy the position, and agreed to purchase it back in four days at a small increase in price.
Unfortunately, over the weekend the underlying security crashed, and the trader-friend could not repurchase the position, leaving my client with a significant loss in his trading account, and an employer who was extremely upset, to say the least.
That one favor led to a termination of his employment, a lengthy arbitration (which we won), a FINRA investigation and settlement, the loss of his license and ultimately a bankruptcy. While the result might be extreme, it is not unusual.
The SEC recently filed charges against two traders involved in what the SEC labeled a "fraudulent parking scheme" similar to the one I described above. One trader temporarily placed securities in the other's trading book to avoid penalties that would affect his year-end bonus.
The SEC's Enforcement Division alleged that Trader G solicited the assistance of Trader K to evade a policy at his firm that penalizes traders financially if they hold securities for too long. Trader G arranged for Trader K, who worked at a different firm, to purchase several securities with the understanding that G would repurchase them at a profit for K's firm. By parking the securities in K's trading book in order to reset the holding period when he repurchased them, G's intention was to avoid incurring any charges to his trading profits and ultimately his bonus for having aged inventory.
The alleged round-trip trades caused G's firm to lose approximately $174,000. The SEC's Enforcement Division alleged that after G's supervisor began inquiring about the trades, G and K took steps to evade detection by interposing an inter-dealer broker in subsequent transactions and communicating by cell phone to avoid having conversations recorded by their firms. G and K were eventually fired by their firms for the misconduct.
K, who cooperated with the SEC investigation, agreed to settle the charges by disgorging his profits and being barred from the securities industry. Any additional financial penalties will be determined at a later date. The Enforcement Division's litigation against G continues in a proceeding before an administrative law judge.
The order against G alleges that he willfully violated Sections 17(a)(1) and 17(a)(3) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. The order alleges that he willfully aided and abetted and caused violations of Section 17(a) of the Exchange Act and Rule 17a-3.
The order against K finds that he willfully aided and abetted and caused G's violations. The Commission took into account K's cooperation when agreeing to the settlement. K agreed to pay disgorgement of $22,606.80 and prejudgment interest of $1,503.66. The cease-and-desist order bars K from associating with any broker, dealer, investment adviser, municipal securities dealer, municipal advisor, transfer agent, or nationally recognized statistical rating organization as well as participating in any penny stock offering, with the right to apply for re-entry after three years.
K did a friend a favor. And lost his license.
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Mark Astarita is a nationally recognized securities litigation attorney, representing firms and brokers nationwide in regulatory, litigation and arbitration matters. He can be reached at 212-509-6544 or by email at mja@sallahlaw.com
