Dealer Settles FINRA Charges for Improperly Claiming Market Maker Status
A broker-dealer settled FINRA charges for failing to comply with the locate requirement under Regulation SHO in connection with equity security short sales that the firm was effectively conducting for the purpose of taking a market risk position.
In a Letter of Acceptance, Waiver and Consent, FINRA stated that for 45 equity security short sales of a single security ("RIVT") on a single day, the firm inappropriately relied on the bona-fide market making exemption under Reg. SHO Rule 203(b)(1) ("Short sales"). As a result, the firm carried out the sales without (i) obtaining the security or entering into a bona-fide agreement to obtain the security, (ii) an adequate basis for believing that the security could be borrowed for the purpose of delivering it by the due date or (iii) keeping record of the sales' compliance with Reg. SHO Rule 203(b)(1). In connection with the 45 transactions which netted $26,720 in profits for the firm, the firm also failed to adhere to its written supervisory procedures that required it to ensure that the bona-fide market making exception was applicable.
The firm had engaged in heavy short selling following its becoming aware that many investors had misunderstood a press release issued by Tesla to mean that Tesla was buying RIVT, causing the company's shares to sky rocket. The firm the next day registered as a market maker in RIVT essentially for the purpose of being able to short the stock without having to borrow it. Its trading activity on that next day was not market neutral, as one might expect a market maker to act, but was heavily tilted towards selling short. FINRA thus determined that the firm's activity was speculative in nature, and was not market making qualifying for an exemption from the Reg SHO locate requirement.
As a result of its findings, FINRA determined that the firm violated Reg. SHO Rule 203(b)(1) and FINRA Rules 2010 ("Standards of Commercial Honor and Principles of Trade") and 3110(b) ("Written Procedures").
To settle the charges, the firm agreed to (i) a censure, (ii) a $35,000 fine and (iii) disgorgement totaling $26,720.