More On Legal & Compliancefrom The Advisor's Professional Library
- Risk-Based Oversight of Investment Advisors Even if the SEC had a larger budget and more resources, it is doubtful that the Commission would have the resources to regularly examine all RIAs. Therefore, the SEC is likely to continue relying on risk-based oversight to fulfill its mission of protecting investors.
- Pay-to-Play Rule Violating the pay-to-play rule can result in serious consequences, and RIAs should adopt robust policies and procedures to prevent and detect contributions made to influence the selection of the firm by a government entity.
On Thursday, the Securities and Exchange Commission accused the firm’s trading arm, OX Trading LLC, with continuing its trading operations after delisting from the Chicago Board Options Exchange (CBOE) and deregistering with the SEC, apparently to avoid an audit.
The SEC’s Division of Enforcement alleges OX Trading, under the direction of former optionsXpress CFO Thomas Stern, operated as an unregistered dealer from October 2009 to November 2010 and illegally transacted in securities while not a member of a national securities association or national exchange.
Schwab's outside counsel handling the matter, Stephen Senderowitz of the law frim Winston & Strawn LLP, said OX Trading "was closed in anticipation of the implementation of the Volcker rule."
In a statement to AdvisorOne, he also pointed out that optionsXpress fired Stern after an investigation. "The allegations against Mr. Stern relating to his post-registration conduct that are contained in the order were self-reported by the company," Senderowitz said in the statement.
According to the SEC’s order, Stern terminated OX Trading’s membership with the CBOE and ended the firm’s broker-dealer registration with the SEC. Meanwhile, OX Trading quietly continued to conduct trading through a customer account at optionsXpress. Stern, who also was OX Trading’s chief compliance officer, later fabricated and backdated an allegedly exculpatory letter purporting to demonstrate that he had properly informed CBOE that OX Trading would deregister and become a customer of optionsXpress.
This is the second spate of bad news for the company in as many days. Earlier this week, the SEC charged optionsXpress, as well as Stern, three other officials at the firm and a customer in an alleged abusive naked short-selling scheme.
In the latest announcement, Daniel Hawke, chief of the SEC’s market abuse unit, said: “OptionsXpress, OX Trading and Stern have displayed a profound disregard for regulators, compliance obligations, and the regulatory requirements that dealers must satisfy for the privilege of operating in our markets. Registration of brokers and dealers is a fundamental part of the regulatory structure and provides the foundation upon which many other investor protections are built.”
According to the SEC’s order, OX Trading and optionsXpress became wholly owned subsidiaries of The Charles Schwab Corp. (SCHW) in September. OX Trading, which originally registered with the SEC in 2008, was created to provide price improvement on orders from optionsXpress customers and to profit from those trades.
The SEC’s order claims a CBOE examiner conveyed to Stern in early 2009 that OX Trading was required to have an annual audit based on its CBOE membership status. Despite CBOE’s request, Stern refused to pay for an audit and subsequently terminated OX Trading’s CBOE membership on March 2, 2009. Nonetheless, OX Trading continued to conduct the same trading through a customer portfolio margin account at optionsXpress. Stern later attempted to furnish the fabricated and backdated letter to SEC investigators in an attempt to prove otherwise.
Schwab's lawyer said: "At one point, OX Trading was registered as a broker-dealer but then deregistered in 2009 because it believed that registration was not required based on the fact it was acting as a proprietary trading firm, had no customer accounts of its own, and didn't advertise for customers, among other reasons."
After Stern was contacted by the SEC’s Division of Trading and Markets, according to the SEC, Stern filed a form with the SEC on Aug. 18, 2009, to deregister OX Trading as a broker-dealer. The deregistration became effective on Oct. 17, 2009. According to an internal e-mail sent by Stern, OX Trading “stalled as long as we could” in deregistering. OX Trading continued to trade through the customer portfolio margin account at optionsXpress.
The SEC’s Division of Enforcement alleges that CBOE identified the OX Trading customer account during an exam of optionsXpress in late 2009. CBOE requested an explanation about why OX Trading was not registered with the SEC as a broker-dealer.
In an internal e-mail about CBOE’s request, Stern stated, “I am happy to spin this however it needs to be.” Stern then sent CBOE a letter containing numerous “factual inaccuracies and no legal opinion or analysis about OX Trading’s registration status.”
CBOE sent Stern another letter in June 2010 informing him that it believed OX Trading was functioning as a dealer and needed to either cease operations or obtain a written opinion from the SEC confirming that OX Trading was not required to register. OX Trading did neither.
According to the SEC’s order, OX Trading eventually acquired a CBOE trading permit and registered again with the SEC effective Nov. 16, 2010.
OX Trading's primary regulator, the CBOE, advised OX Trading that it disagreed with the company's decision to de-register, and thereafter OX Trading re-registered as a dealer. It remained registered until it recently ceased operations.
"OX Trading had no customers and was not a broker," Senderowitz said. "The issue that will be presented to the Administrative Law Judge is whether a trading entity whose principal function was to provide price improvement for its affiliate's customers acted as a dealer, which required registration, or as a proprietary trading firm, which did not.
OptionsXpress is a separate entity, had nothing to do with OX Trading's registration and does not belong in this case."