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The U.S. Securities and Exchange Commission (SEC) sued two individuals engaged in  fraudulent wash trading of so-called "meme stocks."

Wash trading is a market manipulation scheme in which a trader (who acts as a buyer) and a broker (who acts as a seller) conspire to make profits by feeding misleading information regarding the supply and demand of a certain stock. Their main goal is to pump up the value of that stock. In some cases, a market manipulator acts simultaneously as both buyer and seller of the same stock.

In its complaint on Monday, the SEC alleged that a Florida trader named Suyun Gu and his friend Young Lee of California obtained more than $1 million in illegal profits by wash trading meme stocks.

The defendants allegedly engaged in the illegal scheme in early 2021 when certain meme stocks such as GameStop (NYSE: GME) were being actively promoted on social media platforms and message boards including Reddit.

Defendants made illegal profits by taking advantage of the "maker-taker" program by options exchanges

According to the SEC, Gu and Lee took advantage of the "maker-taker" program offered by options exchanges to attract orders and increase market liquidity. Under the program, options exchanges pay a make rebate to broker-dealers for placing non-marketable limit orders that are not immediately executable. A take fee is paid by broker-dealers that direct marketable orders that immediately execute against pre-existing orders. The make fee is smaller than the take fee.

The SEC noted that certain broker-dealers pass the make rebates and take fees to their clients while wholesale market makers don't.

The Commission alleged that Gu and Lee generated illegal profits by "using broker-dealer accounts that passed rebates back to their customers to place initial orders on one side of the market and then using broker-dealer accounts that did not charge fees for taking liquidity for his subsequent orders on the other side of the market."

Gu and Lee allegedly "focused their wash trading scheme on trading out-of-the-money put options in meme stocks that experienced a significant increase in price and trading volume in early 2021. The defendants believed that put options on those stocks are less attractive for other market participants, making it easier to trade with themselves.

The defendants violated the anti-fraud provision of the federal securities laws, according to the Commission.

In a statement, SEC Market Abuse Unit Chief Joseph Sansone said, "As alleged in our complaint, Gu and Lee engaged in a deceptive wash trading scheme to game the exchanges' maker-taker programs and take advantage of market conditions associated with meme stocks trading.

"This case demonstrates the SEC's ability to quickly investigate and expose complex trading schemes, including those conducted during times of significant market volatility," added Sansone.

Lee agreed to settle the charges against him. He consented to the entry of an order requiring him to pay $51,334 in disgorgement, plus $515 in prejudgment interest, and a civil monetary penalty of $25,000. He also agreed to stop violating the anti-fraud provisions of the federal securities laws.

The Commission's lawsuit against Go is ongoing.

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