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Optionsxpress, Inc. and Jonathan I. Feldman (Opinion of the Commission)

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Optionsxpress, Inc. and Jonathan I. Feldman (Opinion of the Commission) UNITED STATES OF AMERICA before the SECURITIES AND EXCHANGE COMMISSION SECURITIES ACT OF 1933 Release No. 10125 / August 18, 2016 SECURITIES EXCHANGE ACT OF 1934 Release No. 78621 / August 18, 2016 ADMINISTRATIVE PROCEEDING File No. 3-14848 In the Matter of OPTIONSXPRESS, INC. and JONATHAN I. FELDMAN OPINION OF THE COMMISSION CEASE-AND-DESIST PROCEEDING Grounds for Remedial Action Close-out Obligations A registered broker-dealer violated its close-out obligations under Rule 204 of Regulation SHO with respect to large and continuing fail to deliver positions that arose from trading activity by its retail customers. Held, it is in the public interest to issue a cease-and-desist order, to order disgorgement of ill-gotten gains, and to impose a third-tier civil monetary penalty against optionsXpress and to dismiss the proceedings as to a retail customer. APPEARANCES: Stephen J. Senderowitz, of Dentons US LLP, and Charles B. Klein, William E. Walsh, and Joseph L. Siders, of Winston & Strawn LLP, for optionsXpress, Inc. Gregory T. Lawrence, Daniel J. McCartin, and Hannah Kon, of Conti Fenn & Lawrence LLC, for Jonathan I. Feldman Frederick L. Block, Christian Schultz, Paul E. Kim, Jill S. Henderson, and Melinda Hardy, for the Division of Enforcement. 2 Appeal filed: July 1, 2013 Last brief received: February 19, 2016 Oral argument: January 15, 2016 TABLE OF CONTENTS I. Summary .........................................................................................................................4 II. Overview of the trading activity .....................................................................................5 A. The Customer’s trading strategy .............................................................................5 B. The continuing cycle of buy-writes resulting from assignments .............................8 C. optionsXpress’s large and persistent fail to deliver positions .................................9 D. An example series of transactions ...........................................................................11 III. optionsXpress background ..............................................................................................13 A. How securities are cleared, settled, and delivered ...................................................13 1. Delivery following a stock transaction .............................................................13 2. Delivery following an option assignment ........................................................16 3. CNS Accounting Summaries ...........................................................................18 B. optionsXpress’s procedures for sending buy-in notices to Customers ....................19 1. Overview of optionsXpress’s process ..............................................................19 2. Procedures from September 2008 to August 2009 ...........................................20 3. Procedures after August 2009 ..........................................................................22 a. The “perpetual fail” list .............................................................................22 b. Pre-building the buy-writes .......................................................................23 IV. optionsXpress analysis ....................................................................................................25 A. The purposes and objectives of Rule 204’s close-out requirement .........................26 B. optionsXpress violated Rules 204 and 204T because it did not close out its fail to deliver positions .......................................................................................27 1. Rule 204(a) unambiguously required optionsXpress to “close out” fails to deliver, which the firm did not accomplish when it relied on its execution of the Customers’ buy-writes to address its fails ........................28 2. The Commission’s releases and other guidance issued by regulators confirm that participants cannot rely upon buy-writes that do not close out fails to satisfy Rule 204(a). ...............................................................................32 a. Guidance on fails and close outs before the adoption of Rule 204T ........32 b. Settled enforcement actions in Hazan and TJM ........................................34 c. Guidance accompanying the adoption of Rules 204T and 204 .................36 3 3. optionsXpress’s arguments are unpersuasive ...................................................37 a. The interpretation of Rule 204 ..................................................................37 b. CNS data ...................................................................................................41 c. Due process ...............................................................................................43 i. Interactions with CBOE .....................................................................44 ii. Interactions with FINRA and Commission staff ...............................46 C. optionsXpress also violated Rule 204 because the transactions it relied upon to comply with that rule were not executed at market open .................49 V. optionsXpress sanctions ..................................................................................................50 A. Cease-and desist order .............................................................................................50 B. Disgorgement ..........................................................................................................52 C. Third-tier civil penalties ..........................................................................................54 VI. Feldman background ......................................................................................................58 A. Feldman was open about his trading strategy ..........................................................58 B. optionsXpress changed its buy-in policy, but told Feldman it wanted to “keep his business” ..............................................................................................59 C. Feldman received assurances from optionsXpress ..................................................60 D. Feldman openly pursued his options strategy at other broker-dealers ....................61 VII. Feldman’s alleged antifraud violations ...................................................................62 A. The Division failed to establish a violation of Securities Act Section 17(a), Exchange Act Section 10(b), or Exchange Act Rule 10b-5 .............62 1. Insufficient evidence of making promises with the intention not to fully perform them .................................................................................63 2. Insufficient evidence of market manipulation ..................................................65 B. The Division failed to establish a violation of Exchange Act Rule 10b-21 ............68 C. No aiding and abetting or causing violations by optionsXpress .............................69 VIII. Constitutional arguments .........................................................................................70 A. The Appointments Clause does not apply to Commission ALJs ............................70 B. Dual for-cause removal restrictions on Commission ALJs are constitutional ........75 4 optionsXpress, Inc., a registered broker-dealer (“optionsXpress”), and Jonathan I. Feldman (“Feldman”), an optionsXpress customer, appeal from an administrative law judge’s initial decision.1 The law judge found that optionsXpress willfully violated Rules 204 and 204T of Regulation SHO of the Securities Exchange Act of 19342 by failing to close out certain fail to deliver positions and that Feldman violated Section 17(a) of the Securities Act of 1933,3 Exchange Act Section 10(b),4 and Exchange Act Rules 10b-5 and 10b-215 by writing call options with the intent not to make delivery of securities when those options were exercised. For these violations, the law judge issued a cease-and-desist order, an order to disgorge ill-gotten gains, and third-tier civil monetary penalties. We find that optionsXpress violated Rules 204 and 204T. But we find that the Division of Enforcement has not met its burden to show that Feldman committed fraud. We base our findings on an independent review of the record, except with respect to those findings not challenged on appeal. I. Summary This matter centers on the concept of “delivery” of securities and the different meanings that term has for clearing broker-dealers (like optionsXpress) and their customers (like Feldman). Rule 204 of Regulation SHO requires participants in a registered clearing agency to deliver securities to the clearing agency within three settlement days of a long or short sale transaction in an equity security (i.e., T+3).6 For purposes of Rule 204, a “fail to deliver” occurs when the participant broker or dealer does not have enough shares in its securities-depository account to satisfy its delivery obligation to the clearing agency. When a fail to deliver occurs, Rule 204 requires the broker or dealer to, “by no later than the beginning of regular trading hours” on the next settlement day (i.e., T+4), “immediately close out its fail to deliver position by borrowing or purchasing securities” of like kind and quantity. Rule 204 applies to participants in registered clearing agencies, and does not 1 optionsXpress, Inc., Initial Decision Release No. 490, 2013 WL 2471113 (June 7, 2013). 2 17 C.F.R. §§ 242.204, 242.204T. 3 15 U.S.C. § 77q(a). 4 Id. § 78j(b). 5 17 C.F.R. §§ 240.10b-5, 240.10b-21. 6 17 C.F.R.
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