Individual Settles SEC Charges for "Free-Riding" Scheme
An individual settled SEC charges for orchestrating a multi-year "free-riding" scheme by exploiting the instant deposit credit feature offered by an online broker-dealer.
In the Complaint, filed in the Eastern District of New York, the SEC explained that in this case, "[f]ree-riding... describes the fraudulent practice... to essentially steal an 'instant deposit' credit extended by certain broker-dealers, by engaging in matched trading in illiquid securities without ever funding the trading account to which the credit was extended."
The SEC alleged that the individual, along with another actor, directed a "matched trading" strategy that involved opening hundreds of unfunded brokerage accounts ("Loser Accounts") in the names of others, while using accounts they controlled ("Winner Accounts") to execute matched trades in illiquid options at inflated prices. The SEC said that the individuals would place "sell to open" limit orders in Winner Accounts for illiquid, deep out-of-the-money put options—often linked to stocks involved in recent merger announcements—and simultaneously execute "buy to open" orders for the same contracts in Loser Accounts. The SEC alleged that the Loser Accounts paid inflated prices for the options, creating guaranteed profits for the Winner Accounts. These trades were quickly reversed with the Winner Accounts buying the options back at market value. The SEC said the multi-year "free-riding" scheme netted over $2 million in illicit profits.
The SEC also alleged that the individuals paid recruiters to solicit individuals, often via Instagram, to open accounts and hand over login credentials in exchange for small payments.
As a result, the SEC charged that the individual violated SEA Sections 10(b) ("Regulation of the Use of manipulative and deceptive devices") and 20(b) ("Liability of controlling persons and persons who aid and abet violations") and SEA Rule 10b-5 (" Employment of manipulative and deceptive devices").
The individual consented to the District Court's final judgment, which included: (i) a permanent injunction from violating the antifraud provisions of the federal securities laws; (ii) conduct-based restrictions on trading in or opening brokerage accounts; and (iii) payment of $525,355 in disgorgement and $122,996 in prejudgment interest, (deemed satisfied by a restitution order in a parallel criminal case).