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SEC Cracks Down on 19 Firms, 1 Trader for Short Selling Prior to Stock Offerings

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A sweeping Securities and Exchange Commission dragnet of short selling violators has hauled in 19 firms and one individual trader. The sanctioned parties will pay $9 million in disgorgement, interest and penalties.

The move comes one day shy of the anniversary of a similar enforcement action against 23 firms deemed to have illegally participated in an offering of a stock after selling it short during a restricted period.

That previous crackdown resulted in a settlement of over $14 million, and taken together, the actions appear to signal the SEC means business in its avowed efforts to enforce Rule 105 of Regulation M, which prohibits short selling a stock within five days of participating in an offering of that same stock.

“Such dual activity typically results in illicit profits for the firms or individuals while reducting the offering proceeds for a company by artificially depressesing the market price shortly before the company prices the stock,” says the SEC in a news release made public Tuesday.

The SEC notes that the short sales occurred “during the last few years” and lists the hedge fund advisors, private equity firms and individual trader involved, noting each party’s disgorgement amount, interest payment and penalty.

Of note, the disgorgement amounts vary widely — from as little as $21,844 for Texas-based Ironman Capital Management and $26,613 for New Jersey-based East Side Holdings II to as much as $2,646,395 for Massachusetts-based RA Capital Management and $1,122,400 for BlackRock Institutional Trust Co.

Yet, while the larger violators appear to pay proportionally large penalties (almost $1 million and over $500,000 for RA Capital and BlackRock Institutional, respectively), it appears that smaller violators paid a minimum penalty of $65,000 whether their disgorgement amount was under $22,000 (Ironman) or as much as $83,722 for Brazil-based Explorador Capital Management.

Steve Insel of Los Angeles-based securities law firm Elkins Kalt Weintraub Reuben Gartside says the SEC crackdown points to the need for financial services firms to increase their compliance efforts.

“Over time people see there is easy money to be made, they see many others doing it, and do not feel there is a significant risk of being caught, and maybe they do not see the likelihood of overwhelming penalties even if they are caught,” Insel tells ThinkAdvisor.

“Then the SEC starts to focus on an issue, and finds many historic violations, cracks down with great publicity, and only then do some firms get their compliance practices in order. So it has always been, and so it is likely to be in the future,” says the veteran securities attorney who handles investigations and enforcement matters involving the SEC and FINRA.

Asked why the SEC appears to be emphasizing enforcement of Regulation M, Insel added that it is normal for the securities regulator  to vary its emphases over time.

“Regulation M is very complex, and unless investment managers both train and supervise their traders, violations are likely to occur.  The SEC announced its examination focus and ramped up enforcement of Rule 105 short sales only a few years ago. 

“You will notice,” Insel continues, “that many of the violations cited in recent enforcement actions occurred in 2009 to 2011.  So this is a stereotypical situation.  The SEC focuses on various issues at various times, it has limited resources that are strained even more since Dodd-Frank, and the SEC has to prioritize.”

In its release, the SEC emphasized that it approaches enforcement in a resource-aware and expedited fashion, coordinating with the Financial Industry Regulatory Authority and the SEC’s National Exam Program to quickly identify potential violators, while gathering trading data from traders.

It then uses “uniform methodologies for determining trading profits and deciding appropriate penalties.  This streamlined effort ensures consistency across all cases while expending a modest amount of agency resources,” the SEC said.

Check out SEC Levies Largest Short Selling Sanction on ThinkAdvisor.