U.S. securities regulators issued an alert Friday designed to help financial firms prevent options trading that’s designed to evade short selling rules.
The U.S. Securities and Exchange Commission’s (SEC) Office of Compliance Inspections and Examinations (OCIE) issued the alert after it says its examiners found options trading strategies that appear to circumvent certain requirements of the short-sale rule.
Under U.S. rules, short sellers who fail to deliver securities after a trade’s settlement date are required to close out their position immediately, unless they qualify as bona fide market makers. The SEC says that its staff uncovered trading strategies that may give the impression of satisfying this ‘close-out requirement’, but actually aim to avoid it. These SEC says that these “sham close-outs” violate the rules, which aim to ensure that trades settle promptly, thereby reducing settlement failures.
The alert describes the strategies used by some investors, broker-dealers and clearing firms, summarizes related enforcement actions, and sets out practices that some firms have found to be effective in detecting and preventing this sort of trading. The bulletin also describes activities that the regulator has observed that may indicate an attempt to circumvent the short-selling rules, including: trading exclusively hard-to-borrow securities, taking large short positions in hard-to-borrow securities, and large failure to deliver positions in an account, among various other red flags.
“The alert describes these trading activities in detail to help broker-dealers and their correspondent clearing firms avoid the regulatory and reputational risks that are posed by these activities,” said OCIE director, Andrew Bowden.