U.S. Securities and Exchange Commission
Litigation Release No. 20480 / March 6, 2008
SEC OBTAINS EMERGENCY ORDERS AGAINST UNREGISTERED DAY-TRADING FIRM AND ITS PRINCIPAL
SECURITIES AND EXCHANGE COMMISSION v. TUCO TRADING, LLC, AND DOUGLAS G. FREDERICK, Case No. 08 CV 0400 DMS BLM (S.D. Cal.)
The Securities and Exchange Commission announced today that on March 4, 2008, it filed an emergency action against Tuco Trading, LLC, an unregistered securities day-trading firm in La Jolla, California, and its principal, Douglas G. Frederick, charging them with violations of the broker-dealer registration and antifraud provisions of the Securities Exchange Act of 1934. On March 5, 2008, U.S. District Judge Dana M. Sabraw of the U.S. District Court for the Southern District of California found that the SEC had made a prima facie showing that Tuco and Frederick have engaged in, and will continue to engage in future violations, of the broker-dealer registration and antifraud provisions of Sections 10(b) and 15(a) of the Securities Exchange Act and Rule 10b-5 thereunder, appointed a temporary receiver as a monitor over Tuco, and issued orders against the defendants for accountings, expedited discovery, and prohibiting destruction of documents.
According to the SEC’s complaint, the defendants provided securities day-trading capability to Tuco’s over 250 traders who had approximately $10.2 million invested in Tuco. They permitted traders to day-trade securities in Tuco’s own brokerage accounts at registered broker-dealers through sub-accounts created at Tuco for each trader. The complaint alleged that Tuco provided traders with services unavailable at a registered broker-dealer. As alleged in the complaint, they allowed traders to day-trade without meeting the $25,000 minimum equity requirement under NASD regulations for such trading. The SEC’s complaint also alleges that for each $1 in the trader’s sub-account, Tuco and Frederick allowed the traders at Tuco to use up to $20 of Tuco’s equity, which has been invested by other traders, to purchase securities (20:1 buying power). NASD and NYSE regulations, however, only allow a day-trader to have 4:1 buying power.
The SEC’s complaint also alleged that Tuco received transaction-based compensation for its members’ trading, and Tuco’s traders conducted substantial day-trading through Tuco’s brokerage accounts both in dollar amounts and number of trades. As a result, Frederick earned substantial commissions on the trading as the registered representative for the Tuco principal accounts at the registered broker-dealer. The complaint alleged that Frederick then used substantial amounts of his commissions to pay Tuco’s operating expenses.
The complaint also alleged that the defendants’ inaccurately reported to the traders their equity balances. Specifically, the complaint alleged that as of December 31, 2007, Tuco and Frederick had used about $3.62 million of the traders’ approximately $10.2 million total equity to pay Tuco’s expenses and to cover trader losses and that as of January 31, 2008, approximately a $1.35 million shortfall remained. As alleged in the complaint, Tuco and Frederick failed to disclose those details or that Tuco and Frederick’s recovery of the shortfall in the traders’ equity is dependent on Frederick’s recovering the funds from third parties.
In its complaint, the SEC also seeks against Tuco and Frederick preliminary and permanent injunctions against future violations of the broker-dealer registration and antifraud provisions of Section 10(b) and 15(a) of the Securities Exchange Act and Rule 10b-5 thereunder, disgorgement, and civil penalties, and against Tuco, a permanent receiver.