Notice, Pursuant to Exchange By-Law 18-2, of Disciplinary
Action Against Keystone Trading Partners, Member
Organization, and Timothy D. Lobach, Associated Person ofKeystone
To:Members, Member Organizations, Participants and Participant Organizations

From:

John C. Pickford, Enforcement Counsel, NASDAQ OMX PHLXSMDATE:July 7, 2011

FINRA Matter No. 20100229926
Enforcement No. 2011-04
On June 8, 2011, the Business Conduct Committee (the “Committee”) issued a disciplinary
decision against Keystone Trading Partners (“Keystone” or the “Firm”), a member
organization of the Exchange, and Keystone’s General Partner, Timothy D. Lobach(“Lobach”) (collectively, the “Respondents”). In response to a Statement of Charges
issued in this action, the Respondents submitted an Offer of Settlement, Stipulation of
Facts and Consent to Sanctions (“Offer”). Solely to settle this proceeding, and without
admitting or denying the charges, the Respondents consented to findings that during theperiod between August 1, 2006 and July 17, 2009 (the “Relevant Period”), they had
violated Rules 203(b)(1) and 203(b)(3) of Regulation SHO promulgated under theSecurities Exchange Act of 1934, as amended (the “Exchange Act”), and Exchange Rules
707, 748, and 1014(b)(ii)(D)(1) by, among other things: (i) failing to close-out fail-todeliver positions (“fails”) within the timeframe specified under Regulation SHO; (ii)
improperly utilizing Regulation SHO’s locate and hedge exemptions; (iii) effecting shamtransactions to reset Keystone’s delivery obligations; and (iv) failing to satisfy Keystone’s
quoting obligations in its assigned options series.
Specifically, Respondents consented, without admitting or denying the charges, to findings
by the Committee that they had effected numerous short sale transactions in at least ten
hard-to-borrow, threshold securities. Respondents had not arranged to borrow thesesecurities because they had improperly relied on the market marker exemption from thelocate requirement under Regulation SHO. Respondents subsequently failed to deliver thesecurities they had sold short by settlement date and were notified by Keystone’s clearing
firm that they had to close out the fail-to-deliver positions by the thirteenth settlementday. Typically, a firm would satisfy its close-out obligation by making large open-market
purchases of the threshold securities with little or no control over execution, and withsignificant exposure to directional market risk. During the Relevant Period, Respondents
satisfied their close-out obligations by routinely effecting short-term, paired transactionsof stock and options that made it appeared that they had purchased threshold securities
and had satisfied their close-out obligations on the books and records of Keystone’sclearing firm. In reality, however, these paired transactions yielded no economic benefit
to Respondents and did not close out their short positions in the threshold securities butrather had simply served to improperly “reset” the 13-day clock to zero, prolong theRespondents’ short position in each of the ten threshold securities beyond 13 consecutive
settlement days, and eventually permitted Respondents to reap approximately $2 million
in profits.
Respondents also consented, without admitting or denying the charges, to findings by theCommittee that during the Relevant Period they had: (i) on 51 occasions on the verysame day they had been “bought-in” by Keystone’s clearing firm, negated the clearing
firm’s buy-in and contradicted guidance provided by the Securities and Exchange
Commission requiring that Respondents be a net purchaser of the open fail position in thesecurity, by selling a near equivalent number of shares; (ii) not acted as a bona fide
market maker in the ten threshold securities in that they had failed to quote in theirassigned options series and their threshold security option activity predominantly
consisted of transactions that enabled Respondents effect a synthetic stock position andaccompanying reset transactions rather than engage in genuine market making activity;(iii) failed to locate securities prior to effecting short sales in the ten threshold securities inlight of the fact they had not engaged in bona fide market making activity; and (iv) failed
to meet their obligation to continuously disseminate two-sided markets electronically in atleast 60% of the options series to which Keystone had been assigned.
Finally, Respondents consented, without admitting or denying the charges, to findings that
Keystone had failed to implement reasonable supervisory systems and controls that weredesigned to ensure compliance with the requirements of Regulation SHO.
Respondents’ Offer was accepted by the Committee and was the basis of its Decision. TheCommittee found that Respondents had violated Rules 203(b)(1) and 203(b)(3) ofRegulation SHO promulgated under the Exchange Act, and Exchange Rules 707, 748, and1014(b)(ii)(D)(1), concurred in the sanctions consented to by them, and ordered theimposition of the following sanctions against Keystone: (i) a censure; (ii) a fine in theamount of $500,000; and disgorgement of profits in the amount of $2,000,000; andagainst Lobach: (i) a censure; and (ii) a three-month suspension in a supervisory
capacity.
For more information, contact:
John C. Pickford, Enforcement Counsel, NASDAQ OMX PHLX, at +1 215 496 5273

 Copyright 2009 The NASDAQ OMX Group, Inc. All Rights Reserved.

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