The SEC charged a Chicago area options trader with violating short selling restrictions when he failed to locate and deliver the shares involved in short sales to broker-dealers and their institutional customers. SEC's Findings and Allegations. Gary Bell allegedly violated the “locate” and “close out” requirements of Regulation SHO, which require market participants to locate a source of borrowable shares prior to selling short and to deliver those securities by a specified date.  Market makers who ensure liquidity in the market are excepted from these requirements if they are engaged in bona-fide market making activities in the security for which the exception is claimed. The Commission enforcement action finds that Bell improperly relied on the market maker exception in his line of business that essentially loaned large amounts of hard-to-borrow stock to broker-dealers, who then provided their customers with locates on those shares and lucrative stock loans of those shares.  The customers then were able to sell short certain securities that they may not have otherwise been able to without Bell’s participation. However, because the stock being provided by Bell was not truly available for delivery to the broker-dealers or their short selling customers, Bell actually was effecting illegal “naked” short sales. Bell allegedly effected naked short sales from December 2006 to June 2007 while working as a broker-dealer himself and then later as the principal trader at Chicago-based broker-dealer GAS I LLC, which no longer is in business.  Bell and GAS engaged in 2 specific types of transactions that violated the locate and close-out requirements of Regulation SHO.

• First type of transaction - a “reverse conversion” or “reversal” - which involves selling stock short and simultaneously selling a put option and buying a call option on the stock.
• Second type of transaction - a combined stock-and-option transaction - essentially a sham that creates the illusion that the party subject to a close-out obligation has satisfied that obligation by buying the same kind and quantity of securities it has sold short.

The transactions by Bell and GAS had the effect of creating a false appearance of compliance with Reg SHO requirements.  The shares that apparently were purchased in the transactions were never actually delivered because they were purchased from a “naked” short seller, and left Bell and GAS with persistent “fail-to-deliver” positions - i.e., they did not deliver shares to make good on their sales of stock.  The market maker exception to Reg SHO was not available to either Bell or GAS because they were not engaging in bona-fide market making activities in these securities. As a result of his short selling violations, Bell received ill-gotten gains of at least $1.5 million. SEC's Agreed Upon Sanctions. To settle the SEC’s administrative proceedings, Bell agreed to a 9-month suspension from association with any broker, dealer, IA, muni securities dealer, muni advisor, transfer agent, or rating agency.  He further will pay $2.1mn in disgorgement, prejudgment interest, and penalties. For further details, go to:   [SEC PR 11-264, 12/13/11].