FINANCIAL INDUSTRY REGULATORY AUTHORITY OFFICE OF HEARING

Financial Industry Regulatory Authority Office Of Hearing-Free PDF

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I Introduction, Market makers are dealers who hold themselves out to all comers as ready to buy or. sell a security for their own account 1 Firms acting in this role promote market efficiency for a. security by react ing swiftly to company news and reported financial results by buying or. selling stock and driving it to a changed price level 2 Because market makers are required to. purchase or sell stock for their own account they incur market risk 3 The difference between the. price a market maker is willing to pay for a security or its bid and the price at which it is. willing to sell a security or its ask price is referred to as its spread 4 The spread. traditionally compensates a dealer for its risk and for providing liquidity and immediacy of. execution 5, A central question in this case is whether a broker dealer s trading in various securities. constituted legitimate market making The Department of Enforcement brought the action. against Respondents Wilson Davis Co Inc Wilson Davis or the Firm along with its. President and Chief Compliance Officer James Snow Snow and Byron Barkley Barkley. the Firm s Head of Trading collectively Respondents Enforcement s Complaint alleges that. the Firm willfully violated Rule 203 b 1 of Regulation SHO the Rule by short selling. several stocks without first borrowing the securities Snow and Barkley are charged with failing. to adequately supervise trading and other activities at the Firm and failing to establish and. implement adequate Anti Money Laundering AML procedures tailored to the Firm s. The allegations involving Wilson Davis trading activity focus on the period between. July 2012 and April 2013 when the Firm through one of its registered representatives engaged. in dozens of short sales of four penny stock securities Enforcement alleges that these short sales. were improper as the Firm did not first borrow the stock as required by the Rule Respondents. do not dispute that the Firm shorted stock without first documenting that it had borrowed the. securities or had reason to believe that the securities could be borrowed But they claim that the. borrow requirement was excused because the Firm executed its short sales as a part of bona fide. market making activities in each of the securities A hearing on the circumstances surrounding. In re Merrill Lynch Sec Litig 911 F Supp 754 758 D N J 1995. Cammer v Bloom 711 F Supp 1264 1287 D N J 1989,Merrill Lynch 911 F Supp at 758. See Certain Market Making Activities on NASDAQ Exchange Act Release No 34 40900 1999 SEC LEXIS 64 at. 2 3 Jan 11 1999, Meyer Blinder Exchange Act Release No 31095 1992 SEC LEXIS 2019 at 20 Aug 26 1992. the Firm s trading in the four penny stocks as well as supervisory and AML violations alleged in. the Complaint was held in Salt Lake City Utah,II Respondents.
Wilson Davis has been a FINRA member since 1968 6 The Firm trades mostly low cost. penny stocks for its customers and in its own account 7 Its principal place of business is Salt. Lake City Utah with branch offices elsewhere 8 Between 2011 and 2014 the Firm employed. between 32 and 44 registered representatives 9 During this period Snow served as the Firm s. President Chief Compliance Officer and AML Compliance Officer while Barkley was the. Firm s Vice President and Head of Trading 10 Snow entered the securities industry in 1996 when. he associated with Wilson Davis 11 Barkley entered the industry in 1969 also when he. associated with Wilson Davis 12 Both remain associated with the Firm 13. III Wilson Davis Short Selling Activity Violated Section 203 b of Regulation SHO. A Findings of Fact, Wilson Davis hired registered representative Anthony Kerrigone Kerrigone as a. trader in September of 2008 14 Although Kerrigone maintained a small number of retail. customers his primary business was trading in one of the Firm s proprietary accounts as a. market maker in various securities 15 Kerrigone s niche as a market maker was the markets of. penny stock companies that traded in high volume following promotional or touting. campaigns 16 Kerrigone researched stocks to find those that were experiencing a run up in price. because they were being promoted and touted even though the securities were generally. worthless and had zippo no value 17 Because the promoters managed to figure out how. Answer Ans 12,Complainant s Exhibit CX 27,Hearing Transcript Tr Kerrigone 410. Tr Barkley 511 13,Tr Barkley 516 17, they d get a lot of people to buy these worthless stocks they presented a trading. opportunity for Kerrigone 18, Once Kerrigone identified a suitable trading opportunity his activity in the security. followed a consistent pattern Kerrigone entered the market of an actively promoted stock by. first selling the security short on the assumption that once the market impact of promotional. activity dissipated the stock would lose value 19 Although Kerrigone typically posted both bid. and ask quotes as a market maker when he was first active in a stock during this early period. his bid quotes were generally not competitive with other market quotes minimizing the. possibility that he would actually purchase any significant quantities of the stock from the market. as he shorted 20 Later as the effect of the promotional activity dissipated and value of the stock. began to fall Kerrigone moved his bid to a competitive level and executed market purchases. of the stock sufficient to cover his short positions 21 During this latter stage his ask quotes. were typically away from the inside and not competitive with other market quotes minimizing. the possibility that he would sell additional stock and increase his diminishing short position 22. After fully covering his short position he exited the market of the security 23 His trading in each. security was brief typically only a few trading days 24 By starting out as a net seller of the. promoted stocks accumulating his short position and then buying to cover the stock he shorted. Kerrigone effectively piggy backed the trajectory of potential pump and dump schemes to sell. stock to the public while it was artificially inflated. Kerrigone and his superiors at Wilson Davis knew that Regulation SHO generally. required a seller to borrow a security before selling the security short 25 But the Firm made no. effort to do so before Kerrigone s short selling Instead the Firm assumed that its trading fell. within an exemption to the borrow requirement provided to Firms who engage in bona fide. market making 26, Kerrigone s strategy was lucrative for both himself and Wilson Davis 27 Kerrigone who.
worked on a commission based on his trading profits made in excess of 15 million between. Tr Barkley 552 53,See CX 1 CX 6 CX 11 CX 16,See CX 1 CX 6 CX 11 CX 16. See CX 1 CX 6 CX 11 CX 16,See CX 1 CX 6 CX 11 CX 16. See CX 1 CX 6 CX 11 CX 16,Tr Barkley 524,Tr Barkley 523 27. Tr Barkley 518 19, 2011 and 2013 28 During this time the Firm similarly made tens of millions of dollars in. profit 29 The strategy is illustrated by Kerrigone s trading in four penny stocks Preventia Inc. PVTA PM E Inc PMEA China Teletech Holdings CNCT and Lot 78 Inc. 1 Preventia Inc, Preventia Inc was a firm that purported to operate an electronic trading platform 30.
There was limited or no trading in the market for the company s stock until promotional activity. began in July 2012 31 On July 9 2012 the website hotstocked com 32 published a promotional. article touting the company and proclaiming PVTA the the hottest stock pick or hottest pick of. the summer that was extremely undervalued at the current market cap with projected profits. of more than 366 percent 33 That day price and volume in the stock spiked and Kerrigone. decided to make a market in the stock by submitting a market maker application to his. superiors at Wilson Davis 34 Kerrigone s market maker application explained that he decided to. make a market in the stock because of a trading opportunity 35. Kerrigone then entered the PVTA market by short selling 36 Kerrigone shorted the stock. exclusively during his first day of trading 37 As Kerrigone continued to short the stock Wilson. Davis posted bid quotes were always significantly away from the inside bid 38 During this first. day of trading Kerrigone accumulated a net short position of approximately 32 400 shares 39. Shortly after the market opened on the second day the price of the stock started to decline and. Kerrigone started purchasing shares to close out his short position 40 Once he shifted direction. Kerrigone was exclusively a buyer and by the close had bought enough PVTA to nearly fully. cover his short position 41 During this period he posted offer quotes for Wilson Davis that were. Joint Exhibit JX 12,Tr Kassar 110 CX 3, The website is an aggregator of promotional materials and newsletters that collects materials from various sources. and disseminates them to the public Tr Kassar 106 07. Tr Kassar 112 CX 3,Tr Kassar 82 84 JX 13,Tr Kassar 78 79. Tr Kassar 79,Tr Kassar 99 CX 4,Tr Kassar 78 CX 1, significantly away from the inside offer approximately 94 percent 42 of the time ensuring that he. would not sell additional stock 43 Because the stock price declined substantially between. Kerrigone s shorts and his subsequent covering purchases he generated trading profits of. 4 032 44 Kerrigone never traded in PVTA again after his brief entry into the market 45 And the. Firm never borrowed or made arrangements to borrow the shares Kerrigone sold short 46 In total. Kerrigone executed at least 13 trades in PVTA during his trading including 7 short sales 47. 2 PM E Inc, Kerrigone traded in another penny stock company called PM E Inc PMEA was. purportedly a solar power technology company 48 Like Preventia there was limited or no trading. in the stock before a flurry of activity in November 2012 49 On November 12 2012. hotstocked com published a promotional article touting the company claiming that as a result. of its proprietary solar technology PMEA is coiled up and poised to explode and its upside is. just mind boggling 50 That day price and volume in the stock spiked and Kerrigone decided to. enter the market 51 Kerrigone s market maker application again explained that he decided to. make a market in the stock because of a trading opportunity 52. As with PVTA Kerrigone entered the market of PMEA on November 21 by shorting 53. Kerrigone executed his initial short sale with another firm at a price more than 28 percent away. from Kerrigone s own quote 54 As Kerrigone continued to short the stock Wilson Davis posted. bid quotes were never at the inside and usually significantly away from the inside 55 During this. Enforcement expained that the Wilson Davis public quotes presented at the hearing were snapshots of the Firm s. quotations at the point in time of specific trades and not necessarily a comprehensive representation of the Firm s. quotations throughout the entire period Tr Kassar 89 Nevertheless given the number of transactions. memorialized and in the absence of evidence to the contrary or reason to believe otherwise we infer that these. snapshots fairly and reasonably approximate the levels of Wilson Davis quotations over the trading period. Tr Kassar 100 CX 4, Tr Kassar 80 CX 1 Kerrigone left the market the next day after one small purchase to close out his position.
Tr Kassar 79,Tr Kassar 141 42 CX 3,Tr Kassar 141 43 CX 8. Tr Kassar 121 JX 14,Tr Kassar 123 24,Tr Kassar 124 25. Tr Kassar 125 27 CX 7, first day of trading every transaction except one by Kerrigone was a short sale and he. accumulated a net short position of approximately 35 000 shares 56 In the afternoon on the. second day the price of the stock started to decline and Kerrigone started purchasing shares to. close out his short position 57 By the close on the second day Kerrigone had bought enough. PMEA to cover his shorts and ended in a net flat position 58 Because the stock price declined. substantially between Kerrigone s shorts and his subsequent covering purchases he generated. trading profits of 8 495 59 Kerrigone never traded in PMEA again after his brief entry into the. market 60 And the Firm never borrowed or made arrangements to borrow the shares Kerrigone. sold short 61 In total Kerrigone executed at least 19 trades in PMEA during his trading including. 11 short sales 62, And while Kerrigone posted bid and ask quotes during the brief period of his trading his. quotations were again calculated to facilitate his trading strategy While Kerrigone was shorting. Wilson Davis posted competitive bid and ask quotes less than 5 percent of the time 63 Its posted. bid quotes were never at the inside and usually more than 10 percent lower than the inside. quote making it unlikely that the Firm s posted bids would result in any actual purchase. transactions 64 And when Kerrigone later covered his short position Wilson Davis posted. competitive bid and ask quotes approximately 7 percent of the time 65 Its posted offer quotes. were almost never at the inside and usually more than 10 percent higher than the inside quote. making it unlikely that the Firm s posted offers would result in any actual sale transactions 66. 3 China Teletech Holding, China Teletech Holding was a company that purportedly sold pre paid calling cards and.
mobile phone handsets in China 67 Like the other companies there was limited or no trading in. the security until the latter part of February 2013 68 On about February 20 2013 an article. the Firm s trading in the four penny stocks as well as supervisory and AML violations alleged in Tr Kerrigone 410 16 Tr Barkley 511 13 17 Tr Barkley 516 17 4 they d get a lot of people to buy these worthless stocks they presented a trading opportunity for Kerrigone 18 Once Kerrigone identified a suitable trading opportunity his activity

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