SEC wants BTIG to drop claims about disgorgement of ill-gotten gains

Shortly after BTIG responded to the Securities and Exchange Commission (SEC) complaint alleging short selling rules violations, the regulator has made it clear that it disagrees with the defenses outlined by the company.

According to documents filed by the SEC in the New York Southern District Court, the regulator wants two of BTIG’s affirmative defenses stricken.

Let’s recall that, in its response to the complaint, BTIG raised four affirmative defenses. The SEC seeks to strike BTIG’s third and fourth purported affirmative defenses because, according to the regulator, they are insufficient as a matter of law.

For its third affirmative defense, BTIG asserts that the “Complaint does not sufficiently plead that BTIG’s alleged violations of the securities laws and/or the regulations promulgated thereunder caused any losses.” The SEC says that there is no requirement in the regulations at issue that the SEC must plead or prove any losses.

Likewise, for its fourth affirmative defense, BTIG states that the SEC “does not have statutory authority to obtain disgorgement from BTIG of any alleged ‘ill-gotten gains,’ as requested in the Complaint.” The SEC argues that it has both statutory and equitable authority to obtain disgorgement. “In any action or proceeding brought by the Commission under any provision of the securities laws, the Commission may seek, and any Federal court may order, disgorgement,” the SEC explains.

Regulation SHO regulates the short selling of securities and was designed, in part, to restrict naked short selling and to reduce failures to deliver.

Rule 200(g) of Regulation SHO requires broker-dealers to mark all sale orders of equity securities as “long,” “short,” or “short exempt.” A sale order may be marked as “long” only if the seller is “deemed to own” the security being sold and: (i) the security to be delivered is in the physical possession or control of the broker; or (ii) it is reasonably expected that the security will be in the physical possession or control of the broker-dealer no later than the settlement date.

Under certain circumstances, an order may be marked “short exempt” if the seller is “deemed to own” the security, “provided that the person intends to deliver the security as soon as all restrictions on delivery have been removed.”An order must be marked “short” if it is neither long nor short exempt.

Rule 203(b)(1) of Regulation SHO—often referred to as the “locate” requirement—generally prohibits broker-dealers from either accepting a short sale order or effecting a short sale for their own account, unless the broker-dealer has borrowed the security, entered into a bona fide arrangement to borrow the security, or has reasonable grounds to believe that the security can be borrowed so that the security can be delivered on the date delivery is due.

According to the SEC’s complaint, from December 2016 through July 2017, BTIG mismarked as “long” or “short exempt” over 90 sale orders from a single hedge fund customer – totaling more than $250 million in sale orders and comprising nearly 160 million shares of stock. This is in violation of Rule 200(g) of Regulation SHO.

BTIG’s customer was not deemed to own the shares of stock sold, because the Hedge Fund: (i) did not have title to the stock; (ii) had not purchased or entered into an unconditional contract binding on both parties thereto to purchase the stock; (iii) did not own a security convertible into the stock that it had tendered for conversion; and (iv) did not have a net long position in the stock. BTIG’s customer was, therefore, “short,” and BTIG should have correctly marked its customer’s sale orders as “short.”

BTIG also did not have the shares of stock that the Hedge Fund sold in its possession or control and did not reasonably expect to receive those shares by the settlement date. Accordingly, BTIG should have marked its customer’s sale orders as “short” on this additional, independent ground.

On each of these over 90 occasions, BTIG also failed to borrow and locate shares before executing these effective short sales, in violation of Rule 203(b)(1) of Regulation SHO.

As a broker-dealer registered with the SEC, BTIG had independent gatekeeper responsibilities under the federal securities laws to ensure that the orders it executed were correctly marked. BTIG was not entitled to simply rely on its customer’s representations concerning order marking. Rather, BTIG was obligated to independently verify that its customer was, in fact, long, before marking the trades.

Further, according to the complaint, BTIG failed to verify that the Hedge Fund was deemed to own the shares of stock sold. BTIG did not have the shares of stock sold in its physical possession or control at the time it marked the sale orders, and BTIG did not reasonably expect that the shares of stock would be in its possession or control by the settlement date.

Also, throughout the Relevant Period, BTIG ignored red flags indicating that the Hedge Fund was making false representations concerning its ownership of securities, which led to BTIG’s improperly marking the sale orders as “long” and “short exempt.” BTIG was aware of the Hedge Fund’s repeated failures to deliver stock for timely settlement.

Despite this and other red flags, BTIG continued to improperly mark the Hedge Fund’s sales as “long” and “short exempt,” without determining that the Hedge Fund was deemed to own the securities sold and that BTIG’s order markings were correct. They were not.

BTIG allegedly benefited its customer in several ways: (i) the Hedge Fund did not have to incur the expense of borrowing or locating shares of stock sold, which were costly and difficult to borrow at the time; (ii) BTIG was able to complete sales on behalf of its customer that otherwise would have been prohibited by a market regulation device; and (iii) the Hedge Fund effectively got two extra trading days to deliver the shares for settlement.

The SEC alleges that BTIG earned approximately $1.6 million in commissions from placing mismarked sale orders for the Hedge Fund. From March through July 2017, the Hedge Fund generated the highest revenue of all BTIG’s prime brokerage customers.

By engaging in the misconduct described herein, BTIG is alleged to have violated Rules 200(g) and 203(b)(1) of Regulation SHO under the Exchange Act. The SEC seeks a judgment against BTIG providing permanent injunctive relief and ordering BTIG to pay disgorgement, plus prejudgment interest, and civil money penalties, as well as other appropriate and necessary equitable relief.

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