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PHLX Exchange Trading Through Sanctions Overturned - SEC Adopts Hopeless Standard

Husky Trading LLC, Eugene O'Brien, Michael Inemer, Stephen Floirendo, Exchange Act Rel. 60180, June 26, 2009

Time since appeal filed – 11 months 2 days
Time since last brief – 8 months 5 days
Pages – 14
Footnotes – 33

The Philadelphia stock exchange found that Husky (an exchange member), O'Brien (president of Husky and a floor broker), Inemer and Floirendo (Husky floor brokers) executed options transactions that either traded through the best bid and offer or were traded ahead of customer orders in violation of exchange rules. "Trading through" is the practice of executing an order at a price that is inferior to the highest available bid or the lowest available offer. "Trading ahead" is the practice of executing trades other than the earliest entered receiving precedence. The exchange ordered various fines against the respondents and suspended the individuals from association for various times.

The Commission overturned the PHLX sanctions.

The trades involved were complex stock-tied option orders. As the Commission explained, these are a kind of contingent trade that involve a multi-component trade involving orders for a security and a related derivative that are executed at or near the same time. The ratio of options to stocks depends on the number of shares necessary to offset the option position. The ratio is specified at the time of the order and remains fixed regardless of the price of the instruments.

At the time PHLX had no rules specifically addressing the execution of such orders. It did have rules relating to "synthetic options" trades that involved an options trade that offset options with one-on-one stock trades.

The Commission rejected respondents' arguments that their trading did not violate PHLX rules. However, in a remarkably brief (one paragraph) conclusion the Commission found that "some level of uncertainty may have existed" concerning the "correct interpretation" of PHLX rules. Thus, the Commission concluded the "circumstances raise a question" about whether the respondents "were properly on notice that their conduct was violative."


The Commission's conclusion here is quite remarkable. I would suggest that the standard the Commission appears to adopt is vague and unworkable. Exactly what constitutes "some" level of uncertainty? When is "some" enough and when not enough? Is it sufficient that merely "a question" be raised about the application of the rules? Do such questions of applicability need to be reasonable? Do the rules of exchanges not apply when uncertainty "may" exist? Does that uncertainty need to be reasonable? Does this interpretive mush apply to all aspects of the securities laws? I think the point has been made so I won't continue to belabor the obvious.

One has to wonder why the Commission couldn't simply state its conclusion in plain english. If it was a fact that the rules were unclear and their application to the trades unclear why not just say so? If the respondents were thus not properly on notice of the application of the rules to their conduct why not just say so? But to rest a decision on "some" uncertainty that "may" have existed that raises "questions" – is to say the least unserious and frivolous. The use of a purported test that involves mere "questions" of applicability and "some" uncertainty obviously opens the door to endless future litigation of what will undoubtably prove to be an unworkable formulation.The Commission can do better than this. Indeed one would expect better from a first year law student.