Broker-Dealer Settles FINRA Charges for Mismarking Short Sales
Commentary by Steven Lofchie
A broker-dealer settled FINRA charges for mismarking principal short sell orders and failing to locate shares available for borrowing in connection with net trading.
In a Letter of Acceptance, Waiver, and Consent, FINRA found that the broker-dealer mismarked approximately 9.7 million principal short sell orders resulting in approximately 390,000 incorrect executions, as "long" in connection with its handling of net trades. The firm also failed to locate shares available for borrowing for approximately 490,000 principal short sales. FINRA said that the broker-dealer imposed a block on its small order router for non-easy to borrow lists after failing to obtain the locates for principal short sales.
FINRA determined that the firm violated (i) Regulation SHO Rule 200 ("Marking Requirements") and (ii) FINRA Rule 2010 ("Standards of Commercial Honor") and FINRA Rule 3110 ("Supervision") by failing to establish and maintain a supervisory system designed to comply with order marking and locate requirements.
To settle the charges, the broker-dealer agreed to a (i) censure and (ii) $175,000 fine.
Commentary
This is another case in which the regulators brought charges against a firm for failing to do a locate where the broker-dealer was executing a "riskless principal" transaction; i.e., buying a security from a customer and then selling it to a third party. See also Clearpool.
There is simply no logic to this, regardless of how the SEC defines the term "riskless principal." There is only one share of stock needed in the two transactions; the share that the customer sells to the broker-dealer and that same share the the broker-dealer sells on. It does not matter whether the two sales are at the same price or slightly different prices; it does not matter whether the first sale is deemed to occur a microsecond before the first trade or a microsecond after: only one share of stock is required. The notion that two shares of stock are required amounts to a pretense that the technicalities of definition are more important than fundamental policy. If the broker-dealer were to borrow a second share of stock to complete the second trade, it would simply have to return the stock immediately.
These two disciplinary actions should be revisited. If they are deemed to be violations of a rule, then it is the rule that should be fixed, not the conduct.