Bloomberg News

OptionsXpress Accused by SEC of Naked Short-Sale Violations

April 16, 2012

OptionsXpress Inc. (OXPS:US), the Chicago brokerage acquired by Charles Schwab Corp. (SCHW:US) last year, was accused by U.S. regulators of using sham “reset” transactions as part of an abusive naked short-selling scheme.

The company and four executives violated Securities and Exchange Commission rules in conducting trades from at least October 2008 to March 2010 designed to give the illusion of compliance with rules governing short sales, the SEC said in a statement today. An OptionsXpress customer was also accused by the SEC of participating in the alleged violations.

In a short sale, an investor borrows shares and sells them with the goal of profiting from a price decline by repurchasing at a lower price and repaying the loan. The SEC’s Regulation SHO requires brokers to close out clients’ short sales within three days and bars them from executing further bets against individual companies until previous sales have been settled.

OptionsXpress, its former chief financial officer Thomas Stern and the customer, Jonathan Feldman, are fighting the agency’s claims, which were filed in administrative court in Washington today.

“We believe the evidence at trial will demonstrate that OptionsXpress timely covered consistent with Reg SHO,” said Stephen Senderowitz, an attorney for OptionsXpress. The firm was in touch with regulators regarding the transactions, no one was defrauded, and the transactions “were not shams and were neither novel nor exotic,” Senderowitz said.

‘Open-Market Trades’

Greg Lawrence, a lawyer for Feldman, said his client “entered into legitimate open-market trades, and he believed, and still believes, that his brokers complied with all rules.” The SEC “is unfairly trying to change the rules through litigation,” Lawrence said.

A phone call to Vincent Schmeltz, Stern’s attorney, wasn’t immediately returned.

OptionsXpress helped its customers buy shares while simultaneously selling call options that were essentially the economic equivalent of selling shares short, the SEC said. The purchase of shares created the illusion that the firm had satisfied the close-out obligation even though they were never actually delivered to the purchasers, according to the order.

Stock-Kiting Scheme

The transactions allowed OptionsXpress and its customers to engage in a “stock-kiting scheme” that deprived true stock purchasers of the benefits of ownership, the SEC said in its order. OptionsXpress had repeated failures to deliver stock in firms including Sears Holdings Corp. (SHLD:US), American International Group Inc. (AIG:US) and Chipotle Mexican Grill Inc. (CMG:US), according to the order.

In January 2010, customers involved in the OptionsExpress trades accounted for an average of 48 percent of daily trading volume in Sears, the SEC said. In 2009, six OptionsXpress accounts purchased about $5.7 billion worth of securities and sold short about $4 billion of options, according to the order.

The SEC settled related claims against three OptionsXpress employees: Peter Bottini, Phillip Hoeh and Kevin Strine, according to a separate administrative order filed today. Attorneys for Strine and Hoeh declined to comment. A phone call to Steven Biskupic, a lawyer for Bottini, wasn’t immediately returned.

In resolving the action, Bottini, Hoeh and Strine agreed to cooperate with the SEC’s investigation without admitting or denying wrongdoing or paying any financial penalties.

Charles Schwab, the San Francisco-based brokerage, agreed to buy OptionsXpress for about $1 billion in stock last year, adding the retail options brokerage founded in 2000 to its equity and mutual fund offerings. The acquisition was completed in September.

To contact the reporter on this story: Joshua Gallu in Washington at jgallu@bloomberg.net

To contact the editor responsible for this story: Maura Reynolds at mreynolds34@bloomberg.net


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