by T. GormanPosted on Posted in SECActions

The Committee on Payment and Settlement Systems or CPSS and the Technical Committee of the International Organization of Securities Commissioners or the IOSCO (whose members include the SEC and the CFTC) published the final report of the Principles of Financial Market Infrastructures or FMIs. This report replaces earlier published standards. The CPSS and IOSC expect the principles to be key in the regulation of FMIs.

FMIs that facilitate the clearing, settlement and recording of monetary and financial transactions are critical in fostering financial stability. The report details twenty-three principles grouped into ten categories regarding the governance and operation of FMIs. The new principles are designed, according to the Bank for International Settlements, to “ensure that the infrastructure supporting global financial markets is robust and thus well placed to withstand financial shock.” The principles include:

Category 1, General organization focuses on governance and the management of risks. It notes that firms should have governance arrangements that are clear and transparent and which promote safety and efficiency while having a sound risk-management framework.

Category 2, Credit and liquidity risk management is keyed to having effective measures to monitor and manage credit exposures including the resources sufficient to cover a wide range of potential stress categories. This includes the default of two participants and their affiliates. Policies should also that require collateral with low credit, liquidity and market risk. Margin should cover credit exposures to participants for all products and the firm should effectively measure, monitor and mange liquidity risk.

Category 3, Settlement is concerned with the finality of settlement which should be at a minimum by the end of the value date or, preferably, intraday or in real time.

Category 4, Central securities depositories notes that a CSD should have appropriate rules and procedures to help ensure the integrity of the securities issued and minimize and manage the risks. If there is two linked obligations the CSD should eliminate principal risk by conditioning final settlement of one on the other.

Category 5, Segregation and portability should be provided for as to the positions and the collateral.

Category 6, General business and operational risk management focuses on general business risk including suggesting that sufficient liquid net assets funded by equity be held to cover potential general business loses, custody and investment risks and the management of operational risk.

Category 7, Access and participation requirements notes that an FMI should have objective, risk-based and publicly disclosed criteria for participation which permit fair and open access.

Category 8, Efficiency and effectiveness provides that the FMI should be efficient in meeting the requirement of its participants and the markets it serves while using procedures to facilitate efficient payment, clearing, settlement and recording.

Category 9, Disclosure of rules, key procedures and market data provides that the FMI should have clear and comprehensive rules and procedures and provide for timely and accurate access to data by the relevant authorities and the public in view of their respective needs.

Category 10, Responsibilities of central banks, market regulators and other relevant authorities concerns the regulation and supervision of FMIs, the oversight of their powers and resources, their disclosure policies and cooperation with authorities.

by T. GormanPosted on Posted in SECActions

Regulation SHO and its close out requirements continues to be a focus of SEC Enforcement. Rules 203, 204 and 204T of Reg. SHO generally require participants of a registered clearing agency to deliver equity securities when delivery is due, typically T+3. If the securities are not delivered the participant has an obligation to purchase or borrow securities of a like kind and quantity to close out the position. In recent months the Commission has brought a number of actions alleging violations of these rules. In those cases participants typically entered into sham transactions in an effort to cloak the fact that they had fail to deliver positions.

Yesterday the Commission entered an Order which charges optionsXproess, Inc., now a subsidiary of The Charles Schwab Corporation, its President and CEO Thomas Stern, and its customer Jonathan Feldman with engaging in such a scheme. In the Matter of optionsXpress, Inc., Adm. Proc. File No. 3-14848 (April 16, 2012). A settled proceeding based on essentially the same conduct was also filed against the firm’s chief compliance officer Phillip Hoch, its vice president of compliance Kevin Strine and another customer Peter Bottini. In the Matter of Peter J. Bottini, Adm. Proc. File No. 3-14847 (April 16, 2012).

The action against the firm claims that by October 2008 optionsXpress had six customer accounts involved in repeated and years long violations of Reg. SHO, using what are called reverse conversions. That position, which in substance is a sham transaction, is created through a series of steps: First the customer simultaneously entering into the sale of a put and the purchase of a call with the identical strike prices and expiration dates. This created a synthetic long position. Next, the customer created a short position by selling deep in the money calls. This eliminated the risk of the stock price. The calls were for hard to borrow securities. After the options were exercised the customers had a synthetic long position and a short stock position for which they were required to deliver shares. Finally, rather than deliver the customers created the illusion of closing out by entering into a buy-write – they simultaneously bought the shares to cover and wrote deep in the money calls for the same number of shares. The buy-write in essence was a matched order for an improper purpose, according to the Order. The positions were profitable for the customer.

From October 2008 through March 2010 firm customers utilized this strategy for the securities of AIG, AMDISYS, Inc., A-Power Energy, BioCryst, Citigroup, Chipotle Mexican Grills and others. As a result optionsXpress had what the Order calls a “continuous failure-to-deliver position in these securities for extended periods of time.”

OptionsXpress knew that the trading was problematic. Despite the fact that there was a series of red flags alerting the firm to the situation the positions remained. Indeed, despite a caution from FINRA and comments from the SEC staff that they had “grave concerns” about the positions, they remained until March 2010 when the CBOE referred two optionsXpress officers to its literature on sham transactions. Subsequently, the positions were closed.

The Order alleges willful violations of Rules 204 and 204T of Reg. SHO. It also charges Mr. Feldman with willful violations of Securities Act Section 17(a) and Exchange Act Section 10(b). Mr. Stern is charged with causing and willfully aiding and abetting the firm’s violations of Rules 204 and 204T and the violations of Mr. Feldman. A hearing has been ordered.

In the related action the three Respondents settled. Each has undertaken to fully cooperate with the Commission in any and all investigations and proceedings related to this matter as part of their offer of settlement. In addition, each agreed to the entry of a cease and desist order based on Rules 204 and 204T of Reg. SHO without admitting or denying the allegations in the Order except as to jurisdiction.