Firm Settles FINRA Charges for Improper Claims of Market Maker Status in Short Sales
Commentary by Steven Lofchie
A firm settled FINRA charges for executing short sales through proprietary trading accounts it had miscoded as market maker accounts.
According to the AWC, the firm executed 25,711 short sales as market maker accounts, which let the firm rely on the bona-fide market making exception to Regulation SHO ("Short Sales") Rule 203(b)(1) ("Borrowing and delivery requirements") requirement to locate securities available to borrow. FINRA found that the coding problem traced back to the firm's account-opening practice. Instead of always opening a new proprietary trading account when a desk asked for one, the firm sometimes repurposed a dormant account from another desk. Where the dormant account had previously served a market maker, its market maker coding occasionally carried over even though the new desk was not engaged in market making. The firm then treated orders routed through those accounts as market making activity and executed them without obtaining or documenting a locate.
FINRA also found that during the relevant period, the firm lacked a supervisory system reasonably designed to catch the problem. FINRA noted that the firm supervised its use of the bona-fide market making exception but did not monitor whether reused accounts remained tied to a market making desk.
FINRA determined that the firm violated Rule 203(b)(1) of Regulation SHO, FINRA Rule 2010 ("Standards of Commercial Honor and Principles of Trade"), and FINRA Rule 3110(a) ("Supervision").
To settle the matter, the firm consented to a censure and a fine of $140,000.
Commentary
The SEC has provided substantial notice that it will be pursuing enforcement actions against firms claiming market maker status without proper justification. The concept is quite explicit: firms claiming a market maker exemption from the locate requirement must be able to demonstrate that the relevant transactions are in the course of making a market.