==========================================START OF PAGE 1====== UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Release No. 37669 / September 12, 1996 ADMINISTRATIVE PROCEEDING File No. 3-9077 : In the Matter of : ORDER INSTITUTING PROCEEDINGS : PURSUANT TO SECTION 21C TUDOR INVESTMENT CORPORATION, : OF THE SECURITIES EXCHANGE ACT : OF 1934, MAKING FINDINGS AND Respondent. : IMPOSING REMEDIAL SANCTIONS : : I. The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that public administrative proceedings be, and they hereby are, instituted pursuant to Section 21C of the Securities Exchange Act of 1934 ("Exchange Act") to determine whether Tudor Investment Corporation ("Tudor") violated Section 10(a) of the Exchange Act and Rule 10a-1 promulgated thereunder. II. In anticipation of the institution of these administrative proceedings, Tudor has submitted an Offer of Settlement which the Commission has determined to accept.-[1]- Solely for the purpose of these proceedings and any other proceedings brought by or on the behalf of the Commission or to which the Commission is a party, and without admitting or denying the findings set forth herein, Tudor consents to the entry of the findings and to the ---------FOOTNOTES---------- -[1]- As part of the settlement of this matter, Tudor has simultaneously consented to the entry of a Final Judgment imposing a civil penalty of $800,000 pursuant to Section 21(d)(3) of the Exchange Act for its failure to comply with the short sale rule. SEC v. Tudor Investment Corp. (D.D.C. 96 CV 02119). ==========================================START OF PAGE 2====== imposition of the remedial sanctions set forth below and to the issuance of this Order Instituting Proceedings ("Order"). III. The Commission finds the following: A. RESPONDENT Respondent Tudor, a Delaware corporation, is, and during the relevant period was, the trading advisor for a number of investment funds. Tudor has trading offices in Greenwich, Connecticut, New York, New York, and Boston, Massachusetts. At all times relevant herein, Tudor traded in United States and foreign markets, including in United States equity securities, on behalf of the investment funds that it managed as part of its normal business operations. B. FACTS On March 15 and 16, 1994, Tudor caused four investment funds to sell short over 1,743,500 shares representing 27 of the 30 stocks listed on the New York Stock Exchange ("NYSE") that comprised the Dow Jones Industrial Average ("DJIA"), in violation of the short sale rule.-[2]- The short sale rule provides, inter alia, that short sales (i.e., sales of a security that the seller does not own) of exchange-listed securities may be effected only at a price above the price at which the immediately preceding sale was effected ("plus tick"), or at a price equal to the last sale if the last preceding transaction at a different price was at a lower price ("zero-plus tick"), established by reference to the reported last sale price. For purposes of determining whether it is long or short a particular security, the holder must aggregate its long and short positions together.-[3]- Because it failed to aggregate its long and short positions, Tudor sold stock with a market value of over $98 ---------FOOTNOTES---------- -[2]- Exchange Act  10(a) and Rule 10a-1 thereunder. -[3]- Exchange Act Rule 3b-3, 17 C.F.R.  240.3b-3, defines the term "short sale." The rule provides that "a person shall be deemed to own securities only to the extent that he has a net long position in such securities." The general purpose of the short sale rule is to prevent manipulative sales of a security for the purpose of accelerating a decline in the price of such security. Exchange Act Release No. 34-20715 (March 6, 1984), 49 Fed. Reg. 9414. ==========================================START OF PAGE 3====== million in violation of the short sale rule in 174 separate transactions on those two days. 1. Tudor's Investment Strategy In February of 1994, the Chairman of Tudor (the "Chairman") believed that the DJIA would rise about one percent in the immediate future, but would decline soon thereafter. He discussed his beliefs with a salesman at a major New York-based securities firm (the "securities firm") and inquired about implementing a trading strategy consistent with this view. The Chairman also wanted the ability to sell the component stocks of the DJIA (the "Dow stocks") without having to meet the requirements of the short sale rule in order to maximize Tudor's flexibility in reducing its holdings. The salesman suggested a "married put" strategy involving the purchase of a large amount of the Dow stocks and a two-week OTC put option for an identical amount of the same securities.-[4]- Based on his conversations with the salesman, the Chairman believed the purchase of the Dow stocks would permit Tudor to sell these stocks without regard to the short sale rule to take advantage of the one percent increase in the DJIA anticipated by the Chairman. It was contemplated by the parties that once all of the Dow stocks were sold, Tudor would exercise its put option. The exercise of the put option would leave Tudor with a sizeable short position in the Dow stocks, which would become profitable if the DJIA declined as the Chairman anticipated. The structuring of the transaction in this manner gave Tudor a dual profit potential: it could profit from the initial sales of the Dow stocks and from the subsequent short position established by the exercise of the put option. 2. Tudor Implements the Married Put Strategy On February 28, 1994, Tudor simultaneously bought from the securities firm 234,600 shares of each of 27 of the 30 Dow stocks (for a total of 6,334,200 shares valued at approximately $350 million) and put options which would expire in two weeks for the same amount of the same securities.-[5]- Tudor purchased the securities for the accounts of four investment funds under its management. The put options were written by the securities firm specifically for this transaction, since there are no listed options for the DJIA. The securities firm sold two put options ---------FOOTNOTES---------- -[4]- A put option allows the option holder (in this case Tudor) to "put" or sell securities to the writer of the option at a designated price. -[5]- The Chairman excluded the three Dow stocks in the oil and energy industries, since he did not believe that these stocks would decline. ==========================================START OF PAGE 4====== to Tudor for the four investment funds, for ten and seventeen of the Dow stocks respectively. The Tudor personnel involved in the transactions knew that in order to properly implement the married put strategy, and thereby avoid the need to meet the requirements of the short sale rule, Tudor had to sell the stock position first and exercise the put options afterwards. Tudor intended to sell all of the Dow stocks it had purchased within several days, well before the expiration of the put options in two weeks. On February 28, the securities firm salesman specifically explained to the Tudor traders that the married put strategy created a situation in which Tudor was "long" both the Dow stocks and the put options on those stocks. The salesman informed the Tudor traders that because of the stock position, Tudor could sell the stock into the market "however you want," selling the position down over the course of a week. He further stated, "When you get out all of your stock, this put you have is American-style so you can exercise then become short stock. . . ."-[6]- 3. Tudor Fails to Sell All of the Dow Stocks as Anticipated The Chairman directed the two Tudor traders to begin selling a portion of the Dow stocks on February 28, 1994, in anticipation of the projected one percent increase in the DJIA. The two traders were instructed to sell 25% of the Dow stocks using the previous day's close as the price limit. They divided the list of stocks roughly in half and sold 1,447,000 shares of the Dow stocks on that day. On March 1, 1994, the Chairman directed the sale of approximately $40 million worth of the Dow stocks over the NYSE's Designated Order Turnaround ("DOT") system through the securities firm.-[7]- The Chairman instructed the securities firm salesman to sell the Dow stocks in four $10 million blocks over a twenty minute period. The DJIA declined at least 12 points during the time period that the 731,700 shares of Tudor's stock were being sold. The Chairman decided that further sales over the DOT system were a "bad idea," because the DOT sales ---------FOOTNOTES---------- -[6]- An "American-style" option is one where the option holder has the right to exercise the option on or before the expiration date. Tudor's put options were American-style options. -[7]- The NYSE's DOT system was developed by the NYSE to facilitate the routing of orders from NYSE members' offices to specialists on the NYSE floor. Exchange Act Release No. 34-32045 (March 31, 1993), 58 Fed. Reg. 16896, at n.3. ==========================================START OF PAGE 5====== contributed to the market decline and made further sales less attractive. On March 3, 1994, Tudor sold an additional 1,638,000 shares of the Dow stocks. Since the DJIA did not rise as anticipated in early March, however, Tudor continued to hold a long position of 2,517,500 shares. 4. Tudor Exercised the Put Options On March 10 or 11, 1994, the Chairman contacted the securities firm salesman and asked whether it was possible to be both long and short simultaneously. The salesman told him that Tudor could be both long and short, if it had a hedged position, and cautioned the Chairman to verify this opinion with Tudor's clearing firm. The salesman's response was based on his indirect and incorrect understanding of a no-action letter from the Commission's Division of Market Regulation to Merrill Lynch, Pierce, Fenner & Smith, Inc. The salesman had never read the no- action letter and it did not apply to Tudor's Dow stock trading strategy.-[8]- The saleman's advice was not verified with ---------FOOTNOTES---------- -[8]- See Letter regarding Merrill Lynch, Pierce, Fenner & Smith, Inc. (December 17, 1986), 1986 SEC No-Act LEXIS 3010. Pursuant to the Merrill Lynch letter, any person may sell stock short without regard to the provisions of Exchange Act Rule 10a-1 if: (1) the firm has a "long" stock position as part of an index arbitrage position; (2) the stock is being sold in the course of "unwinding" an index arbitrage position; and (3) the sale would be deemed to be a short sale as defined in Rule 3b-3 solely as a result of the netting of the index arbitrage position with one or more short positions created in the course of bona fide arbitrage, risk arbitrage, or bona fide hedge activities as those terms are employed in Securities Exchange Act Release No. 15533. The no-action letter defined an index arbitrage position as the concurrent purchase or sale of all stocks comprising a securities index, or a "basket" of such stocks consisting of a sufficient number of stocks comprising the index to closely track the day-to-day price movement of the index, and an offsetting transaction in a financial futures contract or a standardized option contract on that index, provided (continued...) ==========================================START OF PAGE 6====== Tudor's clearing firm. Tudor had not sold 2.5 million shares of its long position in the Dow stocks by March 14, 1994, the date the put options were set to expire. On March 14, the Chairman again asked the securities firm salesman if "I could just stay simultaneously long and short stocks and get out of my longs if I want?" The salesman responded, "Yeah, right, whatever you know,. . . yeah, you could." Tudor's Chairman replied, "That's what I am doing." According to the salesman, he understood that he was being asked simply whether it was possible to maintain both positions at the same time, and not whether compliance with the short sale rule was required. The salesman thought that Tudor had talked to its clearing firm about their previous conversation. Tudor exercised the put options on March 14, 1994, even though it still held approximately 40% of its long position in the Dow stocks. As a consequence of the exercise of the put options, Tudor sold 6,334,200 shares of the Dow stocks to the securities firm, creating a net short position of 3,816,700 shares in the 27 Dow stocks. 5. Short Sales on March 15, 1994 The Chairman instructed the two Tudor traders to sell half of Tudor's remaining position in the Dow stocks. Accordingly, during the morning of March 15, Tudor sold a total of 1,320,000 shares of the Dow stocks without informing the executing brokers that the sales were short sales. At least 152 separate sales (resulting from 23 orders) were not on plus ticks or zero-plus ticks in violation of the short sale rule. 6. Tudor Alerted to Short Sale Problem On the morning of March 16, a Tudor employee spoke with an employee of Tudor's clearing firm, who stated that Tudor had a net short position in the Dow stocks and had to comply with the provisions of the short sale rule in liquidating the remainder of its holdings in the Dow stocks. The Tudor employee informed one of the two Tudor traders of this conversation and explained that after netting the long and short positions, the firm was short the Dow stocks. The Tudor trader stated that if the advice were correct, the March 15 sales were short sales. After consulting with each other, the two Tudor traders decided to seek advice ---------FOOTNOTES---------- -[8]-(...continued) that the index arbitrage position relates to a securities index that is the subject of a financial futures (or options on such futures) contract traded on a board of trade and/or a standardized options contract as defined in Rule 9b-1(a)(4) under the Exchange Act. ==========================================START OF PAGE 7====== from some of their market contacts. The two Tudor traders did not consult with anyone at Tudor, including Tudor's in-house counsel. One of the Tudor traders contacted a firm which he believed to have experience with married put transactions. The Tudor trader described a hypothetical married put scenario that mirrored the actual position of Tudor, i.e., the firm exercised the put option before it sold all of its long stock. The Tudor trader asked his market contact whether the firm could sell the remaining long stock without regard to the short sale rule. The market contact incorrectly suggested that the firm could continue to sell long stock after the exercise of the put option. The market contact then asked one of his co-workers to join the conversation. The Tudor trader repeated his hypothetical for the second employee, who advised the Tudor trader that he should not exercise the option if he wanted to avoid the need for compliance with the short sale rule. The second employee said that the firm would be short upon exercise of the option, confirming the correct advice previously provided by Tudor's clearing firm. After this conversation, the Tudor traders consulted the securities firm salesman who earlier had incorrectly suggested to the Chairman that Tudor could sell without regard to the short sale rule. The salesman told one of the Tudor traders that Tudor had to show a separate hedge by a futures or options position against the remaining position in the Dow stocks. The securities firm salesman said, "You know, what you just can't have is like a long or short position against each other and then sell out the longs because of the fact that, that you know that's considered selling short. You know, you actually have a short position."-[9]- The Tudor trader asked the salesman if Tudor could hedge the Dow stocks against a short S&P position and sell the Dow stocks as long stock. The salesman said that would be satisfactory.-[10]- The Tudor trader incorrectly concluded that because Tudor had a short position in futures contracts for the S&P 500 stocks (resulting from an entirely separate trading strategy) that Tudor could avoid aggregation of its long and short Dow stock positions by claiming to be using a long position in the Dow stocks as a ---------FOOTNOTES---------- -[9]- In fact, this statement accurately describes Tudor's position at the time. -[10]- The securities firm salesman was again drawing upon his inaccurate understanding of the Merrill Lynch no-action letter. See note 8, supra. The relief provided in the Merrill Lynch no-action letter was strictly limited to its terms and did not apply to the Tudor scenario. ==========================================START OF PAGE 8====== hedge against a short position in futures. The Tudor traders concluded that Tudor could sell its long position in the Dow stocks without aggregating its short position in the Dow stocks. 7. Short Sales on March 16, 1994 At approximately 3:39 p.m. on March 16, the Chairman instructed the two Tudor traders to sell the remainder of the Dow stocks at the end of the trading day. The Chairman believed that the DJIA would rise quickly and dramatically just prior to the close of trading at 4:00 p.m. The Chairman thought that this increase would result from a so-called "Paris March," in which other market participants would purchase a large number of Dow stocks because of their holdings in certain options and futures due to expire that week (this time of expiration is often referred to as "Triple Witching Hour"). Pursuant to the Chairman's instructions, the Tudor traders placed market orders to sell the remainder of the Dow stocks immediately before the close of the market. Tudor sold 1,097,500 shares of the Dow stocks at the close of the market. Tudor did not inform any of the 13 executing brokers that the sales were short sales. As a result, all of the 24 sales transactions were treated and reported to the market as long sales. Of these 24 sales, 22 transactions for a total of 1,038,000 of shares were not on plus ticks or zero-plus ticks, and therefore failed to comply with the short sale rule.-[11]- These concentrated short sales by Tudor of the Dow stocks were a significant factor in the DJIA's drop of 16.45 points (a loss of 0.43%) from 3:56 p.m. to the close. The effect of this drop was to produce an approximate $1,500,000 gain in the value of Tudor's remaining short position in the Dow stocks. Tudor did not attempt to realize such gain and closed out its short position over a period of several months beginning in May of 1994, ultimately incurring a loss of approximately $3,300,000. C. LEGAL DISCUSSION Tudor was aware of the short sale rule and that the rule placed restrictions on the manner in which Tudor could sell the Dow stocks. Although Tudor employed the married put strategy to avoid the need to comply with the restrictions of the short sale rule, it did not follow the strategy as originally conceived, and found itself in a position where compliance with the short sale ---------FOOTNOTES---------- -[11]- The fact that 92% of the sales did not comply with the short sale rule is not surprising, because of the large volume of sales by Tudor in a very short time frame. The initial sales would increase the supply of the stock, thus lowering the price and creating a situation where further short sales were prohibited. ==========================================START OF PAGE 9====== rule was necessary. Tudor's failure to comply with the short sale rule violated Section 10(a) of the Exchange Act and Rule 10a-1 thereunder. On March 16, 1994, after learning from Tudor's clearing broker that this trading activity may have resulted in a number of short sales the preceding day in violation of Rule 10a-1, the Tudor traders searched for an opinion from other market participants that compliance with the short sale rule was not necessary. The information received from Tudor's clearing broker and one of the two employees of a firm experienced in married put transactions that compliance was required should have caused Tudor to seek an opinion from an authoritative source, such as Tudor's in-house counsel. However, the Tudor traders did not seek the advice of counsel, ultimately relying on the incorrect opinion of the securities firm salesman. By not aggregating the firm's positions as required by Exchange Act Rules 3b-3 and 10a-1 after the exercise of the put options on March 14, Tudor erroneously treated the transactions in the Dow stocks on March 15 and 16 as long sales. Because Tudor failed to inform its executing brokers that the transactions were short sales, at least 174 short sales were not executed on plus ticks or on zero-plus ticks as required by Exchange Act Rule 10a-1(a). The sales on March 16, 1994 were a significant factor in the drop of approximately 16 points in the DJIA. IV. FINDINGS Based on the foregoing, the Commission finds that Tudor violated Section 10(a) of the Exchange Act and Rule 10a-1 promulgated thereunder. V. OFFER OF SETTLEMENT Tudor has submitted an Offer of Settlement in which, without admitting or denying the findings herein, it consents to the Commission's issuance of this Order, which makes findings, as set forth above, and orders Tudor to cease and desist from committing or causing any violation or future violation of Section 10(a) of the Exchange Act and Rule 10a-1 promulgated thereunder. VI. ORDER ==========================================START OF PAGE 10====== Accordingly, IT IS HEREBY ORDERED THAT: Tudor, its affiliates, subsidiaries, successors and assigns, and any entity which is controlled by the current controlling shareholder of Tudor, and, directly or indirectly, conducts or directs investment, asset management, or investment advisory activities relating to securities, shall cease and desist from committing or causing any violation or future violation of Section 10(a) of the Exchange Act and Rule 10a-1 promulgated thereunder. By the Commission. _____________________________ Jonathan G. Katz Secretary