2004
CASE ANALYSIS

In the Matter of the Application of AMR ELGINDY and Key West Securities, Inc. For Review of Disciplinary Action Taken by NASD
Securities Exchange Act of 1934 Release No. 49389, March 10, 2004

http://sec.gov/litigation/opinions/34-49389.htm

 A Little Background

Amr Elgindy, formerly the owner, sole executive, and chief trader of Key West Securities, Inc. ("Key West" or "firm"), a former member of NASD, and Key West appeal from an NASD disciplinary action, which found that they engaged in a manipulative scheme and violated NASD rules regarding communications with the public.  NASD barred Elgindy, expelled Key West, and imposed a $51,000 joint and several fine.

Saf T Lok, Inc. ("Saf T Lok") made safety mechanisms for firearms. On the morning of October 9, 1997, however, the Associated Press reported that then-President Clinton had signed an agreement requiring handgun manufacturers to provide child-proof safety locks to each purchaser of their handguns. It appears that this news excited investor interest in Saf T Lok.  However, by October 9 the company was nearly insolvent and faced deslisting from the NASDAQ SmallCap market (its stock traded under the symbol "LOCKC;" the "C" denoted that the company was subject to imminent delisting).  There were as many as twenty market makers in Saf T Lok, and on October 9 and 10 they traded more than 32,000,000 shares of Saf T Lok in increments of 1/32 and lots as small as 100 shares. Over the 16 trading hours on those two days, market makers entered more than 16,000 quote updates. On October 9, Saf T Lok opened at $0.43 per share and closed at $3.00 on volume of 12,036,089 shares, up from 147,473 shares the previous trading day. On October 10, Saf T Lok closed at $4.56 on volume of 17,642,215 shares. 

Also on October 9, the firm failed to execute 21 orders to buy Saf T Lok shares at the firm's posted bid price; some of the 21 orders were withdrawn, and others lapsed because they "timed out," that is, they were not filled within a pre-determined period. Elgindy testified that, when orders appeared on his computer screen, he had either to "execute" or "cancel" them before doing anything else on the computer, or his computer would "freeze." Elgindy testified that, if he were working on another task when Key West received an order, his practice was to cancel the new order on the screen, finish what he was doing, and then turn to the new order. On October 9, each time Elgindy returned to an order that he had cancelled, the order either had been withdrawn or had timed out. Elgindy testified that he called the brokers whose orders he had not filled to see whether they still wished to do the deal. None of the brokers Elgindy contacted wanted to complete the transaction. Elgindy did not receive any complaints from brokers whose orders he had not filled. An NASD witness testified that NASD had not received any complaints about Elgindy "backing away" from the firm's bid. 

On October 10, between 9:27:19 a.m. and 3:58:24 p.m., Key West effected another six short sales for a total of 12,000 shares, increasing Key West's short position in Saf T Lok to 58,000 shares. On October 10, Elgindy issued two more negative press releases on Saf T Lok (one at 11:13 a.m. and another at 2:27 p.m.). Key West subsequently issued two more press releases on October 24 and November 11, respectively. All five press releases accurately reported on Saf T Lok's financial troubles and the fact that there was no reasonable prospect that its business would increase as a result of the new mandate. Elgindy later accurately reported that the senior management of Saf T Lok had sold their shares in the company.  Elgindy did not disclose in any of the press releases that the firm made a market in Saf T Lok stock. In an interview with a reporter from Bloomberg News Service, Elgindy did disclose that the firm made a market in Saf T Lok stock. Bloomberg reported that fact in a story on Saf T Lok published on October 10 at 10:29 a.m. and 11:13 a.m.  

Elgindy testified that he sold Saf T Lok short because he thought it was a poor investment. Elgindy thought that the increase in the price of Saf T Lok was based on a misunderstanding. Elgindy concluded that, when investors understood that the safety-lock mandate would not benefit Saf T Lok, the price of Saf T Lok would collapse.The firm ultimately lost money on the short sales.

 NASD Decisions

Preliminarily, an NASD hearing panel concluded that Elgindy had not manipulated the market for Saf T Lok stock because the firm lacked the requisite market power to do so. The hearing panel found that Elgindy and the firm had engaged in conduct inconsistent with just and equitable principles of trade by "backing away" from the firm's bids for Saf T Lok stock and that Elgindy violated NASD rules on public communications by failing to disclose in the press releases that the firm made a market in Saf T Lok stock.   The Hearing Panel suspended Elgindy and the firm for one year, fined each $2,000 for failing to honor the firm's bids, and fined Elgindy $1,000 for issuing recommendations regarding Saf T Lok without disclosing the firm's market maker status.

Subsequently, the NASD National Adjudicatory Council ("NAC") reversed the hearing panel's dismissal of the manipulation charge, finding that Elgindy and the firm had engaged in a manipulative scheme with respect to Saf T Lok stock as alleged in the complaint. The NAC did not reach the question of the Applicants' backing away from the firm's bids for Saf T Lok stock. The NAC affirmed the Panel's findings that the press releases violated the NASD's rules on public communications. NASD barred Elgindy from association with any NASD member in any capacity, expelled Key West from NASD membership, and fined Applicants $51,000 jointly and severally ($50,000 for the manipulative conduct and $1,000 for the violation of public communication rules). 

On Appeal to the SEC

What is the legal definition of "manipulation"?

The SEC defines "manipulation" as "intentional interference with the forces of supply and demand." Brooklyn Capital & Securities Trading, Inc., 52 S.E.C. 1286 (1997) (quoting Pagel, Inc., 48 S.E.C. 223, 226 (1985), aff'd, 802 F.2d 942 (5th Cir. 1986)). Determining whether a person has engaged in a manipulative scheme depends on inferences from a variety of factual detail, patterns of behavior, and, among other things, trading data. Brooklyn Capital & Securities Trading, Inc.  Courts have suggested that manipulation requires the injection of inaccurate information into the market or creation of a false impression of market activity. See, e.g. GFL Advantage Fund, Ltd. v. Colkitt, 272 F.3d 189, 205 (3d Cir. 2001).

What characteristics are typically evident in manipulations?

Manipulations may be characterized by a rapid surge in the price of a security dictated by the firm that controlled the market for that security, little investor interest in the security, an abundant supply of shares of the security, and the absence of any known prospects for the issuer or favorable developments affecting the issuer or its business. Brooklyn Capital.  

• Market domination, 
• maintenance of high bid prices, 
• absorption of all shares sold by others into inventory, 
• abuse of price leadership resulting from almost exclusive control over the supply of the shares, and 
• a failure to reflect genuine market conditions 

are also characteristics of manipulation. Michael J. Markowski, Securities Exchange Act Rel. No. 43259 (Sept. 6, 2000), 73 SEC Docket 625, 629 (citing Patten Securities Corp., 51 S.E.C. 568, 574 (1993)), aff'd, 274 F.3d 525 (D.C. Cir. 2001), cert. Denied, 537 U.S. 819 (2002).

Doesn't Key West's lack of the power necessary to move the market dispose of this case in its favor?

As an initial matter, the SEC agreed with NASD that whether a respondent has adequate market power to successfully manipulate a market is not dispositive of whether the respondent engaged in a manipulative scheme. Success is not a prerequisite for a finding of manipulation. Markowski, 73 S.E.C. Docket at 630.  Pointedly, NASD contended that four facts, when taken together, establish that Elgindy attempted to manipulate the market for Saf T Lok stock: 

1. Elgindy bid up the price of Saf T Lok and then sold the stock short; 
2. Elgindy sold Saf T Lok stock short at the firm's bid; 
3. Elgindy issued five press releases with negative coverage of Saf T Lok; and
4. the firm failed to honor the bids Elgindy entered for Saf T Lok.

But Key West and Elgindy noted that there were twenty market makers in Saf T Lok; Key West's transactions were a minimal percentage of the Saf T Lok volume. Key West had no supply of the security; and there was substantial, if misguided, interest in Saf T Lok based on the press reports. . .  doesn't that all refute any allegation that the firm and individual had the power to manipulate the market?

To a large degree, yes.  Ultimately, the SEC could not conclude that Key West's sales at the bid evidenced a manipulative scheme; moreover, if there had been any upward pressure exerted by the firm's bids, the firm's contemporaneous broadcast short-sale orders provided countervailing information to the market indicating Key West's negative view of Saf T Lok.  On October 9, before Key West had entered its bids, investors had begun to bid up the price of Saf T Lok stock, apparently based on a misunderstanding of the new gun safety agreement. The firm was among the twenty market makers in Saf T Lok stock and was responsible for only a small percentage of the trading in Saf T Lok. For a few minutes (and sometimes for a few seconds) out of that trading day and of October 10 the firm was at the inside bid. The amount of time that the firm was at the inside bid amounted to less than one percent of the trading time those days. The price of Saf T Lok stock was rising before Elgindy began updating the firm's quotations, and continued after the firm ceased to be the inside bid in the market. The record did not support a finding that either the firm's few and relatively brief escalating bids or its short sales or its negative press releases were part of a scheme to manipulate Saf T Lok trading.

NASD emphasized the manipulative power of the five negative press releases but the statements contained therein seemed accurate.  Can there be manipulation by truth?

The dissemination of accurate information in the securities market is not a manipulative act. In re Olympia Brewing Company Securities Litigation, 613 F. Supp. 1286, 1292 (N.D. Ill. 1985). See also GFL Advantage Fund, Ltd. v. Colkitt, 272 F.3d at 205 (proof of manipulation requires showing that manipulator injected inaccurate information into the marketplace). Edward J. Mawod & Co., 46 S.E.C. 865, 870 n.24 (1977), is not to the contrary. In Mawod, the reports that we found to be part of the manipulative scheme were accurately reporting facts concerning wash sales and matched orders that themselves fabricated an appearance of trading activity. Mawod, 46 S.E.C. at 871-2 (frustrating investors' expectations that supply and demand determine prices paid and received, essence of manipulation is substitution of fiction for fact). While Elgindy failed to disclose in the press release that Key West was a Saf T Lok market maker, he did disclose that information to Bloomberg.

What about Key West's failure to honor its bids for Saf T Lok stock?

NASD established that Elgindy and the firm did not honor the bids for Saf T Lok entered by the firm. Although this fact could be evidence of manipulative intent, by itself it is, at most, equivocal. Even in combination with the other evidence in this record, the SEC could not find that the backing away by the firm established a manipulative scheme.  Although the NASD hearing panel dismissed the manipulation charge, it still found a violation of NASD Conduct Rule 2110 by publishing bid quotations that the firm did not intend to honor. The NAC reversed the hearing panel on the manipulation charge. The NAC did not consider the hearing panel's finding of a violation of NASD Conduct Rule 2110 by publishing bids and not honoring them.  Such conduct, if found, could support a violation of failure to observe just and equitable principles of trade. However, because the NAC neither made findings regarding the backing away conduct, nor imposed sanctions regarding that conduct, there was no finding of violation or final disciplinary action before the SEC.

What about the failure to disclose the firm's market making capacity in the press releases?

Elgindy and Key West did not dispute the allegation that the five press releases recommending that investors sell Saf T Lok violated NASD's rules regarding communications with the public in that the press releases did not disclose that Key West made a market in Saf T Lok securities. Accordingly, the SEC found that Elgindy and Key West committed these charged violations. 

  The Verdict

The SEC set aside in part and sustained in part the NASD's disciplinary action.  Accordingly, it dismissed Elgindy's bar and the expulsion from membership of Key West Securities, Inc.  Furthermore, the SEC dismissed the $50,000 joint and several fine (manipulative conduct), but sustained the $1,000 joint and several fine (public communications).