SEC Sanctions University Professors For Naked Short Scheme

Two university professors settled fraud charges brought in an SEC administrative proceeding centered on a naked short selling scheme. The scheme yielded profits of over $400,000. In the Matter of Gonul Colak, Adm. Proc. File No. 3-15712 (Jan. 3, 2014).

Milen Kostov, a professor at an unidentified university, created an options trading scheme crafted to evade restrictions on naked short selling, profiting from pricing differences for hard to borrow securities and from holding the positions open. He shared the strategy with his friend Gonul Colak, also a professor at an unidentified university. Under their agreement the profits were shared.

The trading scheme involved four steps:

1) Mr. Colak established an account and took a synthetic long position created from puts and calls with the same strike price and expiration. A synthetic short position would also be created using calls and puts with the same strike price and expiration. That position used deep-in-the money call options.

2) Mr. Kosov established an account at a different firm. Deep-in-the-money call options would be purchased by placing and pricing the buy orders so that they matched the sell orders from Mr. Colak’s account. Mr. Kosov then exercised the deep-in-the-money call options. The shares would be sold immediately into the market.

3) Typically the exercise of the options in step 2 above resulted in the call options being assigned at the end of the day to Mr. Colak’s account which held a large part of the open interest.

4) Respondents did not purchase the shares as required by the notice to Mr. Colak’s account. Rather, they entered into a “reset” trade under which Mr. Colak’s account purchased the stock and, at the same time, wrote deep-in-the-money call options for the same number of shares. This created the illusion of cover in accord with the notice while in actuality leaving the short position open and uncovered – that is, naked.

The strategy, which would be repeated, was implemented for stocks that were hard to borrow. This made the cost of the options higher in relation to the price for others where the shares were more readily available. While typically the price of the put and call options would be in parity, that frequently does not occur with the hard to borrow securities because of the price premium. This disparity permitted Respondents to generate trading profits.

By not delivering shares sold Respondents profited at the expense of purchasers of the shares. The “[f]ailure to deliver can have a negative effect on shareholders, potentially depriving them of the benefits of ownership . . .” according to the Order. Those losses were roughly equivalent to the profits Respondents were able to make on the transactions.

This strategy was executed using twenty different stocks beginning in mid 2010 and continuing until early 2012. It generated profits of about $420,000 which Respondents shared.

To conceal their trading approach Respondents took three steps. First, they used multiple accounts. Second, they frequently reassured brokerage firms that the short position was temporary and outside of their control which was not correct, according to the Order. Third they moved the short position from firm to firm every few days.


To resolve the proceeding each Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order. In addition, Mr. Colak agreed to pay disgorgement of $285,600 along with prejudgment interest and a civil penalty of $150,000. Mr. Kostov agreed to pay disgorgement of $134,000, prejudgment interest and a civil penalty of $70,000.

Reset transactions, such as those used here, were also part of a short selling scheme at the center of In the Matter of Jeffrey A. Wolfson, Adm. Proc. File No. 3-14727 (Jan. 31, 2012). That proceeding alleged violations of Regulation SHO.

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