Firm Settles Charges for Short Sales Violations
Commentary by Steven Lofchie
A firm that provides execution services for broker-dealers settled FINRA charges for short sale violations by failing to locate shares available for borrowing in connection with "net trading."
According to the AWC, the firm "incorrectly believed that it could rely on a broker-dealer client's locate when effecting a short sale for its own account to facilitate net trading." FINRA found that the firm "effected at least 10 million short sales for its own account to facilitate short sale orders on a net basis without borrowing the securities, entering into a bona fide arrangement to borrow the securities, or having reasonable grounds to believe the securities could be borrowed so that they could be delivered on the date delivery was due."
FINRA also found supervisory failures, among them, that the firm's written supervisory procedures stated that firm representatives could "rely on a broker-dealer client's locate when facilitating a client order through a separate principal order for the firm's account."
As a result, FINRA found that the Firm violated SHO Rule 203(b)(1) ("Short Sales") and Rules 3110 ("Supervision") and 2010 ("Standards of Commercial Honor and Principles of Trade").
To settle the charges, the firm agreed to (i) a censure, (ii) pay a $250,000 fine and (iii) an undertaking to remediate the issues identified.
Commentary
This is an issue where FINRA may be technically correct, but where the violation makes no sense from a policy perspective. The theory behind the enforcement action is that there are two separate short sales—one from the client to the broker-dealer and a second from the broker-dealer to the street—and therefore, it is necessary to locate pools of borrowable securities, one pool for each short sale.
In the real world, there is need for only one pool of borrowable securities. The client borrows securities to deliver to the broker-dealer, and the broker-dealer on-delivers those same securities to the street. Requiring the broker-dealer to locate a second pool of securities to borrow serves no economic purpose; it is simply telling the firm to dig a hole and fill it back up.