“Regulation SHO is an important federal securities rule meant to protect the market and investors from short sale abuses,” said Susan L. Merrill, Chief of Enforcement, NYSE Regulation. “As these cases demonstrate, firms that fail to enact effective procedures and systems by the compliance date threaten to undermine the important policies served by this rule.”
The U.S. Securities and Exchange Commission adopted Regulation SHO (“Reg. SHO”) effective September 7, 2004 in connection with the sales of equity securities. Among other things, Reg. SHO was designed to establish uniform locate and buy-in requirements in order to address problems associated with failures to deliver. The Member Firm Regulation Division of NYSE Regulation (“MFR”) first detected the violations at each firm during special examinations conducted within six months of January 3, 2005, the date for compliance with Reg. SHO. MFR referred its findings to the Division of Enforcement for further investigation.
A “failure to deliver” occurs when a seller does not deliver the securities by the settlement date. Reg. SHO attempts to reduce the number of potential “failures to deliver” by, among other things, the application of a “locate” requirement. Prior to effecting a short sale, a broker-dealer must obtain a “locate” by borrowing the security, entering into an arrangement to borrow, or having reasonable grounds to believe that the security can be borrowed and delivered by settlement date.
Reg. SHO also limits the time in which a broker-dealer can permit “failures to deliver” to persist in securities in which a substantial number of fails have occurred (“threshold securities”) by requiring a broker-dealer to “buy-in” the securities in the open market in order to make the required delivery. The NYSE and other self-regulatory organizations daily disseminate a list of threshold securities.
Among the violations cited in NYSE Hearing Board Decisions Nos. 06-113 (Daiwa Securities America Inc.), 06-128 (Goldman Sachs Execution & Clearing L.P.), 06-111 (Citigroup Global Markets Inc.) and 06-112 (Credit Suisse Securities USA LLC) are the following:
Daiwa Securities America Inc.
From January 3 through April 15, 2005, one of the firm’s proprietary trading desks effected approximately 103,000 short sales without obtaining locates and the firm did not prevent it from doing so. In addition, another proprietary trading desk, which acted as the firm’s stock loan desk, failed to document compliance with the locate requirement; and the firm failed to mark certain proprietary orders “long”, “short” or “short exempt”.
The firm utilized independent trading unit aggregation to determine its net position prior to effecting a sell order without having a written plan of organization identifying each trading aggregation unit as required by Reg. SHO and therefore improperly calculated its net positions. The firm also failed to reasonably supervise its business activities because it did not have adequate policies and procedures. The hearing board decision noted certain corrective measures taken by the firm. The NYSE imposed a censure and a $400,000 fine. Daiwa Securities America Inc. consented to the penalty without admitting or denying the allegations.
Goldman Sachs Execution & Clearing, L.P.
From January 3 to August 2005, the firm failed to ascertain that orders were properly marked “long”, “short” or “short exempt” in various instances; and with respect to customer orders, to ascertain that sell transactions for securities that were not in the Regulation SHO pilot program, but were exempt from the tick/price test of Exchange Act Rule 10a-1, were properly marked short exempt, relying solely on its customers to mark these orders.
The firm failed to monitor customer short sales to ascertain whether previous borrowings arranged by the customers had resulted in timely deliveries and therefore whether the firm had reasonable grounds to rely on customers’ assurances. Similarly, the firm failed to monitor customer “long” sales to ascertain whether such sales repeatedly required borrowed shares for delivery or resulted in “failures to deliver”.
The firm also improperly marked certain sales for one of its own accounts as long when those transactions were short sales. In addition, the firm failed to properly calculate and age its fails in threshold securities by failing to combine its positions on two clearing platforms at the Depository Trust Company (“DTC”). Further, the firm failed to reasonably supervise its business activities because it did not have adequate policies and procedures, and failed to maintain accurate books and records. The NYSE imposed a censure and a $350,000 fine. Goldman Sachs Execution & Clearing, L.P. consented to the penalty without admitting or denying the allegations.
Citigroup Global Markets, Inc.
From January 3 through July 13, 2005, the firm inaccurately accounted for “failures to deliver” in threshold securities by not combining fails on its two clearing platforms at DTC. In addition, the firm failed to reasonably supervise its business activities because it did not have procedures for resolution of fails in threshold securities that existed for 13 days, as required.
The firm did not have policies and procedures to prohibit a short seller from covering short sales executed during the Regulation M restricted period with offering securities purchased from an underwriter or broker, or dealer participating in the offering. The NYSE imposed a censure and a $250,000 fine. Citigroup Global Markets, Inc. consented to the penalty without admitting or denying the allegations.
Credit Suisse Securities (USA) LLC
From January 3 to September 2005, the firm failed to obtain locates for certain short sales it effected for clients to whom it provided direct market access and algorithmic trading execution services. In addition, the firm failed to monitor customer “long” sales to ascertain whether such sales repeatedly required borrowed shares for delivery or resulted in failures to deliver and consequently whether the firm had reasonable grounds to believe customers would deliver securities prior to the settlement dates.
The firm also failed to reasonably supervise its business activities in that it did not have adequate policies and procedures. The hearing board decision noted certain steps taken by the firm during the relevant period. The NYSE imposed a censure and a $250,000 fine. Credit Suisse Securities (USA) LLC consented to the penalty without admitting or denying the allegations.
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