Alert to Broker-Dealers and Hedge Funds: SEC Charges Broker-Dealer with Naked Short-Selling Violations

IM Report Alert to Broker-Dealers and Hedge Funds: SEC Charges Broker-Dealer with Naked Short-Selling Violations Debbie A. Klis · May 28, 2021

On May 19, 2021, the Securities and Exchange Commission (“SEC”) charged a broker-dealer, BTIG, LLC (“BTIG”), with repeatedly violating the (i) order-marking and (ii) locate provisions of Regulation SHO, in connection with more than 90 sale orders from a single hedge fund customer. Regulation SHO regulates short sales of securities and is aimed, in large part, at reducing the number of naked short sales, the failures to deliver, and other practices.

By way of background, “naked short selling” is unlawfully short selling shares that have neither been borrowed nor located. If sellers are engaged in naked short selling, then the volume of stock may be larger than the tradeable shares in the market, which can lead to sellers failing to deliver securities sold by the settlement date.

According to the SEC’s complaint, from December 2016 through July 2017, BTIG violated Rule 200(g) of Regulation SHO when it mismarked more the sale orders from a hedge fund customer-representing total sales of more than $250 million-as “long” and “short exempt” when those orders should have been marked as “short.”

According to the SEC, as a registered broker-dealer, BTIG had independent gatekeeper responsibilities to ensure that its trades were correctly marked. The SEC alleges that BTIG ignored facts indicating that the hedge fund’s representations, that it owned the securities it was selling and that it would deliver them by the settlement date, were false. In particular, the SEC alleges that BTIG was aware of prior compliance concerns regarding the hedge fund, the hedge fund’s net short position in the securities it was selling in its BTIG account, statements by hedge fund employees indicating that they did not expect to deliver the securities by the settlement date, the hedge fund’s failure to provide documentation showing that it owned the securities on the trade date, and the hedge fund’s repeated failure to deliver the securities by the settlement date.

Despite these and other red flags, BTIG allegedly continued to mark the hedge fund’s orders as “long” and “short exempt” without taking reasonable steps to determine whether those order markings were correct. In addition, the SEC alleges that because BTIG failed to borrow or locate the shares before effecting what were, in reality, short sales, BTIG also violated Rule 203(b)(1) of Regulation SHO.

The SEC’s complaint, filed in the Southern District of New York, charges BTIG with violating Rules 200(g) and 203(b)(1) of Regulation SHO. The SEC seeks injunctive relief, disgorgement of ill-gotten gains with prejudgment interest, and civil penalties. According to the SEC’s Complaint, “[s]hort selling occurs when an investor borrows a security and sells it on the open market, planning to buy it back later for less money.” Thus, short sellers profit from a decline in the price of a security. This is in contrast to “long” investors, who profit from an increase in the price of a security.

The SEC’s complaint can be found here: https://www.sec.gov/litigation/complaints/2021/comp25092.pdf

Debbie represents private investment funds, investment advisers, SPACs and issuers in connection with public and private securities offerings, fund structuring, advertising, private placement procedures, compliance policies and procedures, side letters, placement contracts, related agreements and issues. Debbie’s experience includes private equity funds, venture capital funds complex partnership reorganizations, domestic and offshore hedge funds, Opportunity Zone Funds, real estate investment funds and trusts, EB-5 funds, and large master-feeder structures.  Debbie has extensive experience with private securities offerings and financial products, including through crowdfunding, domestic and international joint ventures, global equity offerings, where she represents placement agents, issuers, broker-dealers, public and private companies, investment banks, financial institutions, private funds, and investment advisers.

Debbie also represents family offices, private funds, investment advisers and other clients in connection with impact investing including establishing Environmental, Social, and Governance (ESG) investment policies and practices and with policies regarding anti-money laundering (AML), Foreign Corrupt Practices Act (FCPA), derivatives and FINRA and SEC-compliant investment regimes and operations.