Wall Street Doesn't Prosecute Its Own
By Edward Manfredonia
May 7th, 2009
So you actually thought Wall Street was a clean place where smart people made smart decisions that resulted in lots of money?
I was a trader on Wall Street. If you've been following my columns for the last few weeks you must have learned one or two things.
Let me share another incident today.
In 2007 the American Stock Exchange published a startling, at least to the neophyte, disciplinary decision. The disciplinary decision involved Scott H. Arenstein, a member of the American Stock Exchange, and the method by which he sold stock short, which is selling the stock without owning the stock, utilizing the market maker exemption of Reg SHO.
Reg SHO regulates short sales of stock; it limits the ability to sell stock short. It applies to market participants, who wish to sell stock short that is sell the stock without owning the stock. Reg SHO mandates that the short seller, i.e., the individual who sells the stock without owning the stock, must first verify that he can borrow the stock from someone who owns the stock.
But there is one major exemption. That exemption is for market makers, in this instance members of the American Stock Exchange who make markets in equity options, that is buy and sell equity (stock) options (puts and calls) on the floor of the American Stock Exchange.
The disciplinary decision was meant to showcase the American Stock Exchange regulatory apparatus and the harsh sanctions, which are imposed upon those Amex members who violate the Securities Exchange Act of 1934.
That disciplinary decision was for the neophyte, the hatchling that upon birth is exposed to the cold cruel waters where sharks swim.
But the decision has even misled attorneys- including class action attorneys.
To quote from the American Stock Exchange Disciplinary Decision, Case No. 07-71 of July 20, 2007 Brian Arenstein violated the Securities Exchange Act of 1934, specifically:
(1) SEC Rule 203(b)(1) in that Respondents (Scott Arenstein and his firm SBA Trading LLC- author’s note) who were not acting as bona fide options market makers, improperly utilized the Reg SHO market maker exemption…
This is further explained in:
(2) … in that Respondents failed to meet their in-person, on-floor, assigned class and quoting obligations …
What does this mean, you might inquire?
Simply put, Arenstein did not himself execute the orders himself to buy and sell options in the stock that he sold short. Arenstein used a floor broker, which the illiterates who write for The New York Times and The Wall Street Journal call floor traders, to execute the trades.
When you are a market maker on the Amex, you yourself are required to physically execute on the floor of the Amex approximately 80% of the trades for your account. Floor brokers can only execute 20% of the trades for your account. Thus if Arenstein himself had executed the option trades, he would not have been disciplined for selling the stock short. But Arenstein himself did not execute the options; Arenstein had a floor broker execute the trades for Arenstein’s account.
Also, stated was that Arenstein did not make two-sided markets, that is offer to buy and sell the options of the stock that he sold short- i.e., function as a market maker in the options of the stock that he sold short with the market maker exemption.
That is it.
The whole decision, which everyone thought would expose illegal short selling, did nothing of the sort.
Arenstein was disciplined not because he sold stock short; but, because Arenstein had an Amex floor broker execute the option trades for him.
Everything else, which is too technical to explain in this space, especially Arenstein’s use of FLEX options, is extraneous- specifically because no other Amex market maker was disciplined for trading with Arenstein.
Scott Arenstein was required to disgorge profits of $1,400,000 and was fined $3,600,000. Arenstein was also suspended for five years from membership with any American Stock Exchange Member Organization.
My sources at the Amex stated that Arenstein had earned in excess of $15 million dollars in this scam.
Section 32 of the Securities Exchange Act of 1934 provides that any person who willfully violates any provision of the Securities Exchange Act of 1934 is punishable by imprisonment of not more than two years for each violation of the Securities Exchange Act of 1934.
Yet, Arenstein was never criminally prosecuted because no one from the American Stock Exchange is ever prosecuted on criminal charges. Not for money laundering. Not for narcotics smuggling. (Note even for rape--which occured while I was trader on Wall Street and I reported numerous alleged sexual assaults by a high ranking member of the AMEX to the FBI, to the Department of Justice, and to the SEC and other entities: The assaults were never investigated).
It was precisely Scott Arenstein’s violations of federal securities laws that enable him to live on Central Park West.
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