SEC Enjoins Firm Trading Binary Options That Guaranteed No Losses
The Enforcement Division’s focus on retail investors is illustrated by a recent offering fraud case brought by the Commission. The key elements of that action were: a fund run by a person that worked in the financial industry, giving him the mantel of apparent expertise; solicitations to friends who trusted him; offering reassurances to the inexperienced investors that only a small investment was required; and a guarantee against loss. The approach equaled comfort for the inexperienced, small retail investor. What those investors did not understand was the actual trading history of the approach the portfolio manager intended to use — it generated huge losses in his personal account. Indeed, some places ban it as gambling. It is called binary options. SEC v. Spark Trading Group, LLC, Civil Acton No. 1:18-cv-01498 (E.D.N.Y. Filed Mar. 12, 2018).
Spark Trading Group is a limited liability company owned by Defendant Niket Shah. In 2016 Mr. Shah was employed by a hedge fund in New York City as an administrator. In that position he was essentially a middle office support person, charged with tasks such as accounting and bookkeeping.
Mr. Shah began trading binary options for his own account. That product, sometimes called “all or nothing options,” is regulated by the CFTC in this country. Essentially the option is an all or nothing bet on the price of an underlying instrument. The purchaser buys an option paying part of the standard $100 price of the option. If the bet is correct and the option moves into the money – the price of the underlying instrument reaches the projected level — the buyer is paid the full $100. If the buyer was incorrect about the price movement, nothing is paid. The buyer is guaranteed not to lose more than paid for the option initially.
Mr. Shah traded binary options for his own account. Specifically, over a period from May 2016 to February 2017 he lost more than $29,000.
Undeterred, Mr. Shah opened Spark Trading and what he called Spark Fund I to investors in March 2017. 240 shares of Spark Fund 1 were offered to investors at $1,000 per share – a total of $240,000. The fund would be a “proprietary trading business,” investors were told. It would trade exclusively in binary options and traditional stock options. Investors would be paid 75% of the profits per share. The fund would retain the remaining 25% of the profits.
The safety of the investment was a key marketing pitch. The offering materials told potential investors that $240,000 in equity capital backed the start-up firm. Accordingly there would be no loss incurred by investors. The amount of capital invested would be exactly the minimum each investor would be able to liquidate to the first year. Stated differently, investors could not lose. Investors were directed to wire their funds directly to Mr. Shah’s personal bank account.
Mr. Shah began marking the shares to a friend who then told another. The friend, and the friends of the friend, were small, inexperienced investors. Mr. Shah obviously recognized this, stressing to potential investors in a brochure that his fund required only a small investment that was guaranteed to ally their skepticism, mistrust and lack of knowledge regarding the investment world. Over time Mr. Shah was able to secure investments first for Spark Fund I and later for Spark Fund II, from 15 investors.
The trading results for Spark Fund I and II mirrored those Mr. Shah achieved for himself – losses. As with his personal account Mr. Shah was undeterred. As the losses mounted in Fund I and Fund II current and potential investors were assured that profits were being made. At times investors were paid returns using money from other investors.
As the losses continued and repayments could not be made investors were told their payments were being withheld because of the government. The IRS had a court order along with the SEC that tied things up; federal agents conducted a raid. But none of this occurred.
By March 2018 the money was gone. Mr. Shah transferred out the last amounts of money in his binary options trading account. His business bank account had a negative balance. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). On March 22, 2018 the Court entered a preliminary injunction, freezing the assets and preserving the documents. An accounting was directed to be done. The litigation is continuing.
Program: Insights Into SEC Enforcement, is roundtable discussion of the Former Directors of the SEC’s Division of Enforcement that will be held on April 3, 2018 beginning a 4:30 p.m. at Georgetown University Law School. The program will be followed by a reception. Registration is available here without charge. The program is sponsored by the SEC Historical Society, the Federal Bar Association, and the Association of SEC Alumni.