Regulation SHO sets forth the regulatory framework governing short sales. Among other things, Regulation SHO imposes a close-out requirement to address failures to deliver stock on trade settlement date and to target potentially abusive "naked" short selling by establishing uniform “locate” and “close-out” requirements. To the extent that fails to deliver might be part of manipulative naked short selling, which could be used as a tool to drive down a company's stock price, such fails to deliver may undermine the confidence of investors who may be reluctant to commit capital to an issuer whose security declined in value as a result of such manipulative conduct. Moreover, issuers may suffer unwarranted reputational damage due to such negative perceptions, which might have an adverse impact on the security's price.
Accordingly, Regulation SHO generally requires market participants to locate shares to borrow prior to effecting a short sale transaction. Regulation SHO has a limited exemption from the locate requirement for options market makers when selling the underlying security short to hedge options positions established during the course of bona fide options market making activities. As described below, Hazan and HCM improperly utilized the market maker exemption to engage in impermissible naked short selling.
From on or about Jan. 3, 2005 to on or about Oct. 20, 2007, despite the fact that neither was acting as a bona fide options market maker in the particular securities in question, Hazan and HCM improperly utilized the market maker exemption to impermissibly engage in naked short selling by failing to locate securities to borrow and then engaged in a series of prearranged close out transactions designed to circumvent their Regulation SHO delivery obligations in such securities by creating the appearance of a bona fide repurchase of the securities they initially sold short. As a result of this violative trading activity, Hazan and HCM were able to maintain impermissible naked short positions in a number of Regulation SHO securities for a virtually unlimited period of time and generated profits in excess of $3 million.
Hazan and HCM consented to findings that they violated SEC Rules 203(b)(1) and 203(b)(3) of Regulation SHO, American Stock Exchange Rule 958-ANTE and NYSE Arca Rules 6.37A and 6.37B. In settling these matters the respondents neither admitted nor denied the charges.
NYSE Regulation appreciates the assistance of the Financial Industry Regulatory Authority (FINRA) Market Regulation Department, whose Staff initially detected the violative activity and provided assistance throughout the course of the investigation. Separately, the SEC initiated and settled an enforcement action against Hazan and HCM based on their parallel investigation of this conduct.
