The Securities and Exchange Commission (“SEC”) alleged that the brothers engaged in illegal naked short-sales after failing to locate and deliver shares involved in short-sales to broker-dealers.  The SEC stated that “[b]y engaging in naked short selling, [Respondents] had a major advantage over competitors who complied with the law and incurred the costs associated with actually borrowing securities.”

Short selling is a legal, advanced trading strategy.  The SEC rules require short sellers to locate shares to borrow before selling them short, and they must deliver the borrowed securities by a specific date. Naked short-selling occurs when the transaction is performed without having borrowed the securities to make delivery.

According to the SEC’s order, from July 2006 to July 2007, Respondents engaged in various types of intricate investment transactions to accomplish their scam.  Respondents were able to engage in “naked” short sales by routinely engaging in combinations of “reverse conversion,” “reset”, and “assist” transactions.  Respondents generated more than $17 million in ill-gotten gains from the transactions involving stocks including Chipotle Mexican Grill, Inc., Fairfax Financial Holdings Ltd., Novastar Financial Inc., and NYSE Group.  Per his own admission, one Respondent stated in a recorded telephone call “[w]hat I sell them is not guaranteed, it never gets delivered, its funny paper.”

The SEC alleged that Respondents violated the locate and close-out requirements of Regulation SHO of the Securities Exchange Act of 1934.