Naked put selling strategy backfires against sophisticated investor

Turkson v. TD Direct Investing, 2016 BCSC 732 is a very difficult case to read and track.  But, it is a rare reported decision on how the courts have treated naked put selling in an investor loss case.  For that reason alone, investment industry compliance officers should read it carefully.

The plaintiff in this case held an investment account with the defendant. The account included margin accounts with options trading and short-selling features. In 2014, the plaintiff wrote several put option contracts for hundreds of shares of publicly traded companies. Shortly thereafter one of the companies (GTAT) filed for creditor protection, and its share price fell significantly. The defendant found that the plaintiff had insufficient margin in his account and made a number of transactions to remedy this, including selling shares in the plaintiff’s account without notice. The defendant also assigned shares in the other company (IMMR) before the options’ expiry date. The plaintiff’s account lost value, and the defendant revoked his options trading privileges. The plaintiff brought an action on numerous grounds including breach of contract, negligence, breach of trust, and fraud.

At summary trial, the plaintiff argued that the IMMR options he wrote were European-style, so that they could only be exercised on their expiry date. The defendant responded that all exchange-traded equity options are American-style. The court accepted the defendant’s position. With respect to the GTAT options, the court found that when a stock is de-listed from an exchange and marked as involved in insolvency proceedings, nothing has changed with respect to the shares themselves. The plaintiff was still liable for the put option contracts he wrote. The plaintiff argued that the sale without his knowledge of some of his shares in order to meet his margin requirement was unlawful. The court found that the terms of the agreements the plaintiff executed with the defendant were a complete defence to this allegation. The plaintiff purported to understand the risks of trading, and should have been aware of the defendant’s rights under the agreements.

The reported reasons for decision are long, complicated, and technical.  The judge had to devote quite a bit of time discussing technical issues of whether this case was appropriate for a summary trial rather than dealing with the substance of the debate. The Plaintiff was self-represented, making it more difficult for the judge to focus on the main issues.  However, despite these challenges, compliance officers for dealers should review the decision as a rare example of the courts grappling with the risks of naked short selling investment strategies.

Contact us if you would like to discuss how this decision may affect you.

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