SEC Charges Traders in Fraudulent “Free-Riding” Scheme

October 26, 2011

The SEC charged a pair of purported money managers with orchestrating an illegal “free-riding” scheme of selling stocks before they paid for them and netting $600,000 in illicit profits.


The SEC alleges that Florida residents Scott Kupersmith and Frederick Chelly portrayed themselves to broker-dealers as money managers for hedge funds or private investors, and they opened brokerage accounts in the names of purported investment funds they created.  Kupersmith and Chelly then engaged in illegal free-riding by interchangeably buying and selling the same quantity of the same stock in different accounts – frequently on the same day – with the intention of profiting on swings up or down in the stock price. Unbeknownst to broker-dealers, Kupersmith and Chelly did not have sufficient securities or cash on hand to cover the trades, and they instead used proceeds from stock sales in one brokerage account to pay for the purchase of the same stock in another brokerage account.

The SEC alleges that when trades were profitable, Kupersmith and Chelly took the profits.  But when the trades threatened to result in substantial losses, Kupersmith and Chelly failed to cover their sales and left broker-dealers to settle the trades at a significant loss.  In total, their brokers suffered more than $2 million in losing trades.

According to the SEC, Kupersmith and Chelly traded through a special type of cash account that broker-dealers offer to customers with the understanding that the customer has sufficient securities and cash held with a third-party custodial bank to cover the trades that the customer makes in the account.  Kupersmith and Chelly never disclosed to broker-dealers that they were instead using proceeds from sales of shares in one brokerage account to pay for their purchase in another brokerage account.  Kupersmith and Chelly also used offshore accounts to facilitate their trading activity.

The SEC stated that, the free-riding scheme occurred in 2009 and 2010, and unraveled when Kupersmith and Chelly failed to deliver shares to settle long sales in various brokerage accounts.

Click here to access this press release.


Categories

Enforcement Actions, Investment Advisers