Pro Se Customer Alleges Unsuitability of Self Directed Put Sales

October 5, 2020

Some litigants jump the gun in an effort to improve the so-called "optics" of litigation. In situations where two parties each have claims against the other, there's a sense that it's better to be cast in the role of the Claimant than of the Respondent. The theory is that it's better to frame the lawsuit in the language of the aggrieved rather than as the alleged malefactor. In a 2019 FINRA arbitration, a public customer representing himself pro se sought to recover hundreds of thousands of dollars in put-sales losses. In response to his claims, the respondent brokerage firm counterclaimed for a couple of hundred thousand in its own claimed damages. And after the arbitrators issued their decision, the litigants moved on to battle it out in federal court.

Case In Point

In a FINRA Arbitration Statement of Claim filed in April 2018, public customer Claimant Hu representing himself pro se asserted suitability and negligence in connection with his alleged sales of put options in the exchange traded fund ProShares Short VIX Short-Term Futures ("SVXY"). Hu sought $437,895.65 in damages plus costs and expenses. In the Matter of the Arbitration Between Jay Z. Hu, Claimant/Counter-Respondent, v. Regal Securities, Inc., Respondent/Counter-Claimant (FINRA Arbitration Decision 18-01515 / August 8, 2019)

Respondent Regal Securities generally denied the allegations and filed a Counterclaim asserting that Hu had breached his August 2017 New Account Agreement when he failed to pay the unsecured debit balance in his account. The FINRA Arbitration Decision states that:

In the Statement of Answer, Respondent confirmed that Claimant opened a self-directed trading account with eOption is [sic] a division of Respondent.

Regal Securities sought $265,338.43 plus interest, attorneys fees, and expenses by way of its Counterclaim.

Discovery Disputes

After a few months of apparent haggling over Discovery, in March 2019, Respondent Regal Securities filed a Motion for the Imposition of Sanctions Against Claimant citing Hu's alleged failure to comply with Discovery orders. As explained in the FINRA Decision:

[B]y Order dated May 8, 2019, the Panel advised that the parties spent approximately 80 minutes describing the discovery process to date, and both parties agreed that the evidentiary hearing scheduled to begin July 23 could proceed as scheduled. In the Order, the Panel directed Claimant to comply with the prior discovery orders and, for Claimant's clarification, itemized the documents to be produced. The Panel also ordered the following: 

2). Regarding documents which have been failed to be produced, the Panel further orders sanctions in accordance with Rule 12212 that it will: 
A) Preclude Claimant from presenting evidence at the hearing in connection with the subject-matter of those documents, and/or 
B) Make an adverse inference against the Claimant at the hearing 

3). The Panel has deferred its assessment of monetary damages in connection with Claimant's failure to comply with the FINRA Code [of Arbitration Procedure] to the conclusion of the hearing. 

After being advised by the Respondent that Claimant had not complied with the above Discovery orders and following Claimant's disagreement with said assertion, the FINRA Arbitration Panel issued a June 4, 2019, Order, which stated in pertinent part that:

1- The Panel finds that the Claimant has continued to fail to comply with discovery orders and guidelines, therefore in addition to previous sanctions assesses a monetary penalty payable by Claimant to Respondent of $23,000. 

2- The Panel denies Respondent's request to dismiss the claims - the hearing scheduled for July 23, 24 and 25th is still on [c]alendar. 

As likely comes as no surprise, On June 27, 2019, Respondent Regal Securities filed a Request for Dismissal of Claimant's Claim citing Claimant Hu's alleged failure to comply with the FINRA Arbitration Panel's June 4th Order. In response the Panel took the request under advisement and eventually denied it.


The FINRA Arbitration Panel denied Claimant Hu's claim. 

The FINRA Arbitration Panel found Claimant Hu liable and ordered him to pay to Respondent Regal Securities:
  • $265,338 in compensatory damages plus interest
  • $43,000 in attorneys' fees; and
  • $23,000 in sanctions per the Panel's June 4, 2019, Order.
Additionally the following fees were assessed by FINRA and/or the Panel:

Claimant Hu: $1,425 Initial Claim Filing fee; $160 Discovery-related motion fee;$200 contested motion for issuance of subpoena fee; and $7,537.50 hearing session fees

Respondent Regal Securities: $2,125 Counterclaim Filing Fee; $1,900 Member Surcharge; $3,750 Member Process Fee; $40 Discovery-related motion fee; $50 contested motion for issuance of subpoena fee; and $787.50 hearing session fees.

Bill Singer's Comment (The FINRA Arbitration)

The fact that Hu's trading was characterized as "self-directed" likely increased his difficulty when it came to demonstrating unsuitability because of the likelihood that he was not trading pursuant to the recommendations of Respondent Regal Securities. Given Hu's pro se status (and assuming that he is not a lawyer), his chance of winning such a claim was marginal at best.

You got to wonder what would have happened here had Claimant Hu not filed his lawsuit seeking $437,895.65 in damages, purportedly for losses that arose from put sales. Regal Securities had a $265,338.43 claim for the unsecured debit in Hu's account, but that was presented as a Counter-claim. Given the amount at issue, I'm guessing that Regal would have gone after Hu in any event. On the other hand, had Hu not fired the first salvo, who knows. If nothing else, Hu's conduct during Discovery earned him an additional $23,000 sanction. Further, if Hu had been able to settle the case, he may not have incurred some $43,000 in his adversary's attorneys' fees -- and also saved the tacked-on fees. 

September 2020 Appeal

In a pro se capacity, Hu filed a Motion to Vacate the Arbitration Award in the United States District Court for the District of Nevada ("DNev"), which Respondent Regal Securities opposed, and, in turn, Respondent filed a Motion to Confirm the Arbitration Award. Jay Hu, Petitioner, v. Regal Securities, Inc., Respondent (Order, DNev, 19-CV-1930). 

Four-Part FAA Test

In characterizing Hu's appeal, the Court notes the four circumstances upon which a court may vacate an arbitration award under the Federal Arbitration Act:

(1) where the award was procured by corruption, fraud, or undue means; 
(2) where there was evident partiality or corruption in the arbitrators, or either of them; 
(3) where the arbitrators were guilty of misconduct in refusing to postpone the hearing, upon sufficient cause shown, or in refusing to hear evidence pertinent and material to the controversy; or of any other misbehavior by which the rights of any party have been prejudiced; or 
(4) where the arbitrators exceeded their powers, or so imperfectly executed them that a mutual, final, and definite award upon the subject matter submitted was not made.

You Just Disagree

Mindful of the above four points, the Court states in part that:

The Court construes Petitioner's pro se pleadings liberally. It appears that Hu argues that the arbitration award should be vacated for each of the four circumstances noted above. However, an extensive review of the record demonstrates that Hu merely disagrees with rulings that went against him and has not met the limited circumstances in which the Court can vacate the arbitration award.

at Page 10 of the Order

Buyer's Remorse

Given the Court's initial analysis of Hu's arguments, it's pretty clear that this ain't gonna go well for him and it doesn't. As to his argument that the FINRA arbitrators failed to provide a sufficient rationale for their award, the Court finds in part that:

Based on the Court's extensive and detailed review of the record in this case, it concludes that the arbitrator's decision can easily be inferred from the facts of this case: Hu, as an experienced trader, took a position that could move against him if the price of SVXY went down. As a result of the volatile market, Hu's position moved against him. Hu did not have sufficient capital to cover his position and, even after Regal's actions to stem his losses, Hu owed Regal $265,338.43. Hu then violated the margin agreement by failing to repay that amount. Thus, the arbitrator's $265,338.43 principal award is easily inferred from the facts before the arbitrators. 

Further, the arbitrators found that Hu intentionally violated their discovery orders and, as a result, assessed against him a monetary sanction, which is within the purview of FINRA arbitrators. While the Court is always initially alerted to potential injustice when pro se parties are sanctioned, the record is clear that the arbitrator's gave Hu ample opportunity to comply with their well-explained discovery orders. Hu's disagreement with them does not give him the right to violate them. Nor does an adverse ruling demonstrate bias on the part of the arbitrators. The mere fact that the arbitrators find in favor of the opposing party does not establish partiality. See Polin v. Kellwood Co., 103 F. Supp. 2d 238, 259-60 (S.D.N.Y. 2000). 

Further, the FINRA panel assessed attorney fees against Hu, as provided by his contract. Thus, because the entirety of the FINRA arbitration award can be inferred from the record, the Court rejects Hu's argument regarding the sufficiency of the rationale behind the arbitration award.

at Page 11 of the Order

The Court made quick work of dispatching Hu's arguments about Regal's alleged efforts to defraud the FINRA Arbitration Panel; his" litany of baseless arguments regarding the FINRA panel's purported partiality;"  his assertions that the arbitration award is irrational and rendered in manifest disregard of the law. Accordingly, DNev denied Petitioner Hu's Motion to Vacate and granted Movant Regal's Motion to Confirm. Finally, the Court entered a judgement for Respondent Regal against Petitioner Hu in the amount of $331,338.43.

Bill Singer's Comment (putting it all in perspective)

As is often the case, the FINRA Arbitration Award offered little in the way of specifics about the underlying dispute -- the Award essentially characterized the case as one involving Hu's "selling put options in ProShares Short VIX Short-Term Futures ("SVXY"), an exchange traded fund." In contrast to that terse recitation, the DNev Order provides us with more grit:

In August 2017, Hu, a long-time statistician1 and owner of a statistical analysis company, opened an individual trading account at eOption, an online discount trading division of Regal. As such, the account was self-directed by Hu, and all trades were unsolicited-which means that Hu made all of his investment decisions entirely of his own accord with no recommendations from eOption. There was no broker or investment advisor associated with his account, and Hu entered all orders himself through eOption's online web-based platform. 

In Hu's new account paperwork, he marked "10+ years" for Stocks, and "10+ years" for Options. Additionally, Hu indicated that his annual income is "$100,000 -$249,999," that his net worth (exclusive of his residence) is $1,000,000 - $3,000,000 and that his liquid net worth is $500,000 - $999,999. Hu also indicated that "the investments in this account will be 1/3 of [his] financial portfolio," which indicated to Regal that his investments did not represent his "life savings," as he now claims in his motion. Hu also indicated "[m]arket speculation" was his investment objective and that his risk tolerance was "[h]igh," both of which are the highest and most aggressive categories on the application.

Hu's option account application also supports his years of investment experience and
desire for speculation. In doing so, Hu again requested the highest level of options trading available at eOption, and further indicated his high income, net worth, years of investment experience, and desire for speculation. Indeed, Hu again marked the most speculative and aggressive trading boxes. Under Investment Objective, Hu marked the most aggressive objective, "[s]peculation," and when indicating what his "[p]rior [o]ption [a]ctivity [h]as [b]een," he marked "[u]ncovered (sales)," again, the most speculative category, and for "[p]rior [o]ption [t]rading [f]requency," Hu indicated he was "[a]ctive," the highest category. Under "[p]rior [o]ption [t]rading [o]ccurred in [w]hat [a]ccount [t]ype," Hu indicated he had traded options using "[b]oth" cash and margin. Out of eight possible boxes he could mark for the category "I plan to use this account for the following (Check all that apply)," Hu marked only one box, again
for the most aggressive category, "[m]arket speculation." Additionally, under [c)ustomer [f]inancial [i]nformation," Hu indicated he had "10+ years" of investment experience with stocks and "10+ years" with options. Finally, not only did Hu mark the most speculative category on every entry on his option application, he also applied for "Level 4" options trading permission, which is the highest, most speculative level of option trading available at eOption.2
= = = = =
Footnote 1: Hu complains that he provided three years of tax returns which show dwindling income to Respondent when he opened his account. His dwindling income is blamed on outsourcing of his type of job. He argues that Respondent should have treated him with kid gloves because of this.

Footnote 2: Hu also utilized this strategy at other brokerages, including Charles Schwab, that also resulted in Hu incurring massive debts to those brokerages.

at Pages 1 - 2 of the Order

The Court carefully reviewed the risk-admonitions and disclosures in the margin account and option account agreements, and, thereafter, placed those warnings in the proper context of Hu's background, which is described in part as that of an:

experienced, high-net-worth trader, Hu engaged in a very speculative strategy of selling uncovered puts. This strategy involves selling put options for cash premiums with limited reserved cash on hand to purchase the underlying stock if it became necessary. Importantly, Hu's strategy also relies on a steady or rising stock price-as opposed to a declining stock price-that causes the option to expire worthless. This is considered a highly speculative strategy, and an unfavorable market move downward could cause the investor to have to post additional margin or liquidate their position at a substantial loss. Hu utilized this strategy, apparently successfully for a period of time, until the market went significantly against him in early February 2018. 

Hu engaged in a high risk, speculative pattern of option trading that took advantage of a low volatility market environment that worked successfully for him from 2017 through early February 2018. He was most likely utilizing the same strategy at several other discount brokerage firms, including, among others, Charles Schwab. 

Specifically, as to Hu's strategy, he was engaging in a "Level 4" speculative options strategy, which involved selling uncovered puts on the underlying security, SVXY, to collect premium, but which also obligates him to buy SVXY shares at the strike price he sold the options at (if the market price of SVXY falls below the strike price). SVXY is an exchange  traded fund (ETF) that seeks daily investment results, before fees and expenses, that correspond to one times the inverse (-lx) of the daily performance of the S&P 500 VIX Short-Term Futures Index. Hu's maximum gain was the premium earned when he initially sold the option, and his maximum loss would occur if SVXY shares fell to zero. 

at Pages 5 - 6 of the Order

Notwithstanding Hu's experience and strategy, calamity befell him when he sold naked SVXY puts.  From September 2017 through early February 2018, Hu earned $64,306.47 in options premium at eOption. At the close of January 31, 2018, SVXY was at $118.11 per share but by February 5, 2018, SVXY closed at $71.82. The Court picks up the thread at this point:

During market hours on February 5, Hu continued to sell more uncovered puts on SVXY to collect even more premium. In the afterhours market on February 5, the market experienced a tremendous volatility spike that resulted in the underlying security, SVXY, substantially falling in value. When SVXY closed on February 5 at a price of $71.82, Hu was not in a margin call situation at the market close. A margin call would have been triggered in Hu's account when SVXY reached a price of approximately $47.05. However, in after-hours trading that day, due to extreme market volatility, the stock plunged to as low as $11.00, which placed Hu in a substantial margin call that required additional funds to be deposited. eOption's risk manager phoned Hu after the close on Monday, February 5 to inform him of the after-hours drop in price.

Hu was short a total of 102 uncovered puts on SVXY, and unfortunately, options do not trade in the after-hours market, and thus there was no opportunity for Hu to cover (i.e. buy back) his option positions on SVXY. When the price of SVXY fell below $47.05 in the after-hours market, Hu was in a margin call.

When the market opened on February 6, 2018, trading of SVXY was temporarily halted and opened hours after most stocks that day, at a price of $11.70 (which was down more than 80%, or $60.12 from the previous close of $71.82/share). eOption's Risk Management Department bought to cover 64 short puts on SVXY and covered a small position on VXX6 at a total cost of $457,605.96-which was the amount of cash that Hu had in his account. In accordance with the Margin Agreement, the firm's Risk Management Department used this balance to cover a portion of the amount he owed, but there was still a remaining amount due. 

Also, 5 puts were assigned to Hu that evening on February 6 that were "deep in the money." A "deep in the money" option has an exercise, or strike price, significantly above (for a put option) the market price of the underlying security, SVXY. Thus, since Hu was assigned 5 "deep in the money" puts that day, he had to purchase 500 shares of SVXY at $70/share, for a total cost of $35,009.00. On the evening of Wednesday, February 7, Hu was assigned another 26 puts (where he had to buy 2600 shares of SVXY) at an expenditure of $228,027.00 (for the breakdown, he bought 1,300 shares at $85, 1200 shares at $90, and 100 shares at $95). This still left Hu's account with a long position of 3,100 shares of SVXY and short 7 SVXY naked puts. 

On Thursday, February 15, eOption's Risk Management Department ultimately liquidated the remaining positions. At that time, eOption sold 3,100 shares of SVXY for approximately $39,990.00 and bought to cover the remaining 7 short puts for approximately $40,044.00. However, there was not enough to cover his entire balance, resulting in a shortfall in Hu's account of -$264,603.77. Hu did not and has not paid this amount.

at Pages 6 - 7 of the Order

For those of you who forgot, on Monday, February 5, 2018, the Dow Jones fell  1,175-point and then another 1,033 points on Thursday, February 8, 2018 -- the worst and second-worst drops in the market's history at the time. 

When all is said and done, Hu was a sophisticated investor, who placed a huge bet and saw the dice roll against him. In the end, it's a fairly classic case of buyer's remorse.