The Securities and Exchange Commission and Nasdaq both say they are committed to protecting investors and providing access to “fair and orderly markets.” But the way the agencies handled the case of the cryptocurrency company Longfin Corp. raises difficult questions about who is being protected and at whose cost.
According to an April 6 press release, the SEC “obtained a court order freezing more than $27 million in trading proceeds from allegedly illegal distributions and sales of restricted shares of Longfin Corp. stock involving the company, its CEO, and three other affiliated individuals.” (Longfin’s most recent SEC filing denies the allegations.) The commission also noted that Nasdaq halted trading on April 6, “shortly before the SEC’s complaint was unsealed,” suggesting the halt came at the agency’s request.
So far, so good. My own research into Longfin revealed little or no business activity; almost everything claimed as “revenue” appears to be related-party transactions from other entities controlled by the CEO and his associates. But for some reason the SEC and Nasdaq, after appearing to fast-track this issue, subsequently kept trading halted for nearly two months. By contrast, a company called LiNiu Technology , which filed a press release with identical language to Longfin’s on the same date, was halted for a mere 10 days and began trading over the counter immediately after being delisted from Nasdaq.
The long halt caused significant harm to short sellers and option buyers—i.e., those who correctly bet against the stock—and rewarded brokers and those on the wrong side of the trade. Specifically, investors who were short the stock at the time of the halt were charged a fee of roughly 200%, split between brokers (some of whom accepted restricted shares from company insiders as referenced in the SEC release, a clear violation of the “know your customer” rule) and stock owners (who were effectively rewarded for buying a worthless security).
An investor short 1,000 shares was charged an annual fee of about $56,000—1,000 shares times the $28.19 price when it was halted, times 2. The fee, assessed daily, amounted to almost $10,000 in fees for the two-month halt. Adding insult to injury, the $28.19 reference price was based on the stock price when it was halted, despite the fact that this reflected a near-tripling of the stock in little more than one trading day—a runup that coincidentally started just after the SEC informed Longfin about its investigation. Thus an investor who shorted 1,000 shares at $10 two days before the halt would have ended up losing about $5,000, even though the stock reopened for trading at $5..
Given short interest of more than two million shares, brokers and share owners collected more than $300,000 a day from shorts, or nearly $20 million for the two-month halt. Along similar lines, those who—again, correctly—bought April and May put options were unable to sell them, and brokers made them extremely difficult to exercise. Several brokers required an entire year’s worth of short fees, as well as up to 500% in margin, to exercise puts, even though it was clear the stock would trade significantly lower when it reopened. Many of these options were written by market makers who happen to be large customers of Nasdaq.
The result is that rather than protecting investors and providing access to markets, SEC and Nasdaq actions prevented investors from transacting, which directly benefited bad actors (company insiders), big players (brokers and market makers) and investors who ignored copious warnings and bought an apparently worthless security. All of this came at the expense of those who correctly bet against the stock and in many cases repeatedly warned others, including the SEC, about the company’s dubious actions.
This case was hardly unique. A company named WINS Finance Holdings was halted under similar circumstances last year for six months. Nasdaq, which said the company declined to provide requested information, for some reason chose not to delist it; shorts were stuck paying fees for the entirety of the halt. (WINS eventually submitted the information.) And investors who bet against China-Biotics, which was halted in November 2013 and subsequently shut down, are still waiting to close their positions—and stuck paying fees—although everyone agrees the company no longer exists.
These situations contribute to perceptions that markets are rigged in favor of big players, and they discourage investors from researching and betting against companies under regulatory scrutiny. Little wonder that investor trust in regulators continues to decline.
Mr. Winig is a writer and investor in Potomac, Md.
Appeared in the July 2, 2018, print edition.