by T. GormanPosted on Posted in SECActions

While insider trading typically garners all the headlines, the Commission has also brought a series of cases focused on another type of trading which also can have pernicious market effects – naked short selling. Recently, the Commission has brought a number of actions centered on claimed violations of Reg. SHO, which deals which short selling

Reg. SHO does not ban short selling. Rather, the regulation was adopted to curb short selling which can have a negative market impact. In adopting Reg. SHO the Commission concluded that naked short selling can have a negative impact on the market, particularly where there are persistent failures to deliver the security not just within the usual three day settlement period but for an extended period. In some instances the amount of “fails to deliver” may be greater than the total public float for the security. This can adversely impact the rights of the buyer of a security, according to the Commission.

To avoid this result Reg. SHO has a “locate requirement” which specifies generally that that market participants seeking to effect a short sale borrow, arrange to borrow, or at least have reasonable grounds to believe that a security can be borrowed within the delivery time. There is a market maker exemption. A second facet of the rule has a “close out” provision which generally requires that a clearing broker who has a failure to deliver for thirteen consecutive days close the position by purchasing the securities in a bona fide transaction.

The action brought against Jeffery Wolfson, his brother Robert, and the firm where they were employed, Anchor Trading II, LLC, alleges repeated violations of both of these provisions of Reg. SHO. In the Matter of Jeffrey A. Wolfson, Adm. Proc. File No. 3-14726 (Jan. 31, 2012). According to the Order, over a one year period beginning in July 2006, the Respondents earned at least $17,375,000 in illicit trading profits in violation of Reg. SHO and specifically Rules 203(b)(1) and 203(b)(3). The profits were made by employing three key schemes to evade the requirements of the Regulation:

Reverse conversions: This transaction ties a short stock sale to a synthetic long position with the same trader and hedges the short position. The synthetic long is created by selling a put option and buying a call option with the same expiration date and strike price. In executing this type of transaction, typically for hard to borrow threshold securities, the Respondents did not comply with the locate or close out requirements. The transaction did however permit them to attract business from prime brokerage firms seeking to create inventory for stock loans on hard to borrow securities.

Reset transactions: In this type of a transaction Respondents appeared to comply with their obligation to purchase the security sold short but in reality did not. Here the security was actually purchased while simultaneously buying from the same counterparty a short term, deep in the money put option (or the reverse). In reality the pairing of the transactions was simply a mechanism to borrow the stock for a day. Stated differently, it was a sham transaction, according to the Order.

Assist transactions: This is essentially the opposite side of the reset transaction. Here Respondents would assist their reset transactions as well as those of others.

This is not the first Commission case in which traders have utilized these types of tactics to try and circumvent the requirements of Reg. SHO (here). It may however be one of the largest.

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by T. GormanPosted on Posted in SECActions

The Commission brought four actions centered on a years long financial fraud at Sheffield, England based Symmetry Medical Sheffield LTD f/k/a Thorton Precision Components, Ltd or TPC. The company is the English subsidiary of Symmetry Medical, Inc., a U.S. manufacturer of prosthetics, medical implants and instruments as well as specialized products for the aerospace industry. One action was brought against the senior executives who orchestrated the fraud. A second names as Respondents the company and its former CFO while a third action, based on SOX 304, was brought against the former CEO and president. The fourth named as Respondents the engagement partner and manager on the audits of the company.

The fraud was the product of a group of senior executives which included Richard Senior, then VP for European Operations, Matthew Bell, then Finance Director, Lynne Norman, then Controller, and Shaun Whiteley, then the Account Manager. The four executives systematically engaged in a fraudulent scheme to inflate the financial results of TPC by understating expenses and overstating assets and revenues. The scheme began as early as 1999, four years before TPC was acquired by Symmetry and five years before the latter’s IPO. Mr. Senior is alleged to have orchestrated the scheme by enlisting TPC’s finance staff.

The key elements of the scheme, which varied over time, included:

  • Premature revenue recognition over a four year period beginning in 1999;
  • Recording fictitious or provisional sales beginning in 2004 and continuing through 2007;
  • Creating false documentation to support the fictitious revenue;
  • Understating the cost of revenues and manipulating inventory; and
  • Other accounting manipulations.

As a result of the scheme net income was overstated for fiscal 2004 by 39%, 2005 by 421%, 2006 by 30%, for the first quarter of 2007 by 131% and for the second quarter of 2007 by –6.4%. In April 2008 Symmetry restated its financial statements for fiscal years 2006, 2006 and the first two quarters of 2007.

SEC v. Senior, Civil Action No. 3:12CV60 (N.D. Ind. Filed Jan 30, 2012) is the action against the four executives involved. The complaint alleges violations of Securities Action Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(B) and 13(b)(5). Each defendant consented to the entry of a permanent injunction, without admitting or denying the allegations in the complaint, based on the sections they were alleged to have violated. Messrs Senior, Bell and Norman will also be barred from serving as an officer or director of a public company. Mr. Bell agreed to pay disgorgement of $136,209 along with prejudgment interest but payment is waivered based on his financial condition. Mr. Senior’s consent defers the resolution of the monetary component of the case pending the completion of assets discovery. Finally, Messrs. Bell, Norman and Whitley also agreed to be barred from appearing or practicing before the Commission as an accountant.

In the Matter of Symmetry Medical, Inc., Adm. File No. 3-14723 (Jan. 30, 2012) is a proceeding against the company and its CFO and Senior Vice President, Fred Hite. The action centers on the same facts alleged in the complaint against the four executives. To resolve the action the company consented to a cease and desist order based on Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). Mr. Hite consented to the entry of a cease and desist order based on Exchange Act Section 13(b)(5) and SOX Section 304(a). In addition, he agreed to pay a civil penalty of $25,000 and to reimburse the company for $185,000 in bonuses and other incentive based or equity based compensation and for stock sale profits. That obligations will be satisfied by paying to the company a combination of cash and vested stock that, collectively, totals $185,000 in value with the stock portion thereof not to exceed $85,000.

SEC v. Moore, Civil Action No. 3:12 CV 61 (N.D. Ind., Filed Jan 30, 2012) is an action against Brian Moore, a U.K. citizen who served as the CEO and president of Symmetry from June 2003 and January 2011. The case is based on SOX Section 304 and does not allege that Mr. Moore knew of the fraud at the company. Mr. Moore resolved the matter by agreeing to the issuance of a final judgment ordering him to reimburse $450,000 to Symmetry which represents certain discretionary compensation paid to him in during the 12 month period following the restated financials.

In the matter of Christopher Kelly, ACA, Adm. Proc. File No. 3-14724 (Jan. 30, 2012) is an a proceeding which names as Respondents two Associate Chartered Accountants in the U.K., Christopher Kelly and Margaret Hebb who were, respectively, the former audit partner and audit manager on Ernst & Young UK LLP’s audits of TPC for 2004 through 2006. The Order concludes that the two accountants engaged in improper professional conduct with respect to the engagements. The matter was resolved with the entry of an order by consent suspending each Respondent from appearing or practicing before the Commission as an account with a right to reapply after two years.

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