SEC Santions Global Day Trading Firm for Trading Practice Known as Layering (with Lofchie Comment)

The SEC settled administrative proceedings against an SEC-registered broker-dealer, based in Toronto, Ontario, and two individuals who were its co-founders, co-owners and CEO and Vice President, finding that the individuals failed reasonably to supervise certain associated persons who were day traders, and who had repeatedly used the firm’s order management system to engage in a manipulative trading practice known as "layering" on U.S. securities markets. Layering. According to the Order, "layering" occurs when a trader creates a false appearance of market activity by entering multiple non-bona fide orders on one side of the market at generally increasing (or decreasing) prices, in order to move that stock's price in a direction where the trader intends to induce others to buy (or sell) at a price altered by the non-bona fide orders. Such trading violates Exchange Act Section 9(a)(2), which prohibits effecting a series of transactions or raising or depressing the price of such security, when done for the purpose of inducing the purchase or sale of such security by others.

Scale. The size and scale of the firm is notable, according to the Order: up to 5,000 traders in 30 countries, including some not thought of as financial centers, with as much as $2.48 billion of buying power that could be spent in the U.S. markets. Apparently, the traders were well equipped with trading algorithms as well.

Control. The brokerage firm had structured its operations in a manner that it believed allowed it to claim that the 4,000 to 5,000 persons who traded through the firm from across thirty countries were its customers rather than, as seems to be the case, persons whom it actually financed and controlled, i.e., associated persons that traded on behalf of the firm. However, the report noted that the firm exercised control over the traders and their activities. In particular, the firm backed the traders with its own capital; determined the amount of its capital available to each individual trader as buying power; enforced daily loss limits on each trader; monitored each trader's profit and loss performance; and had the ability to reprimand, restrict, suspend or terminate the traders, and took a share of each trader's profits.

Notably, the SEC cited In the Matter of John H. Gutfreund, et al., 51 S.E.C. 93, 108, Exchange Act Release No. 31544 (Dec. 3, 1992), with respect to the supervisory obligation of both the Firm’s CEO - for failure to follow up on red flags - and the Firm’s Vice President, finding that the Vice President had the "requisite degree of responsibility, ability or authority to affect the conduct of the employee whose behavior is at issue."

Lofchie Comment: Firms providing direct market access would likely do well to review this disciplinary action and see whether any of their customers might be engaged in similar bad acts. For those who like that kind of book, I note that the disciplinary action makes the bad guys sound like characters in a Neal Stephenson novel. (Cryptonomicon is the one I like.)

View Order in full here (links externally to SEC website).See also: Press Release.