“These errors in reporting short-interest information, including the incorrect verification of its own inaccurate report, resulted in the dissemination of inaccurate information into the marketplace,” said Susan L. Merrill, chief of enforcement, NYSE Regulation, Inc. “The firm’s inattentiveness to the size and frequency of these errors only exacerbated the recurring failures in reporting and supervision.”
This disciplinary action concerned violations of NYSE Rules 342 and 421.
NYSE Rule 421 requires, in part, that member firms submit to the NYSE monthly reports of short positions in securities that are listed on the NYSE. The NYSE in turn relies on the accuracy of these reported short-interest figures in compiling its own calculations of overall short interest in NYSE-listed securities, and in disseminating this information to the marketplace.
Enforcement’s investigation was opened upon a referral from the Member Firm Regulation (“MFR”) division. In instances where there has been a significant change from the prior month in the short position of a given security, MFR asks the firm to verify the accuracy of the current short position number. In April 2004, the firm inaccurately reported to the NYSE short interest of 26,089,923 shares of a certain stock (“XYZ”) when the correct figure was 625,360 shares. MFR twice contacted Lehman regarding the April 2004 report of short interest in this listed security. Lehman verified the erroneous amount, and that amount was reported to the marketplace.
This investigation disclosed that the underlying cause of the XYZ reporting error was the firm's failure to update its systems for determining its short-interest position. Because of this failure, manual entry was required, and a firm employee incorrectly designated the number of XYZ shares into the wrong short and long account types in connection with the unwinding of a swap transaction. The employee transposed the numbers, entering 12,838,810 into the Type 2 account and -12,838,810 into the Type 5 account, thereby increasing the short position to 25,464,563 shares, rather than netting it to zero.
The significant fluctuation in the April 2004 XYZ short-interest position should have triggered heightened vigilance and inquiry by the firm of the short interest reported in that security. This did not occur due to the lack of internal controls and clear policies and procedures for the firm’s short-interest reporting and verification process.
During the investigation, Lehman reported to the NYSE additional errors in its systems and procedures for determining its short interest. Due to these errors, the firm made erroneous monthly filings to the NYSE for approximately three and a half years, between January 2001 and May 2004. Inaccurate reporting by Lehman caused the NYSE’s report of short interest in a particular security in a particular month to be inaccurate in more than 4,000 instances.
The reporting errors stemmed from: (i) the firm’s failure to update and add new accounts to the firm’s computer system used to adjust and correct short positions; (ii) a programming error in that same system; and (iii) the firm’s inclusion of certain syndicate accounts in its reporting.
The firm’s short-interest reporting errors had a material impact on the NYSE’s overall short-interest reporting during this time period.
Additionally, Lehman failed to exercise reasonable supervision over its short-interest reporting activities. The firm did not have written procedures in place for the review and verification of the short-interest reports filed with the NYSE, and provided to its employees conflicting verbal guidelines for this process that resulted in a lack of supervisory review. Moreover, the firm failed to have adequate supervisory systems or procedures in place to monitor, review, and perform follow-up reviews regarding its compliance with applicable short-interest reporting requirements, and failed to implement internal controls designed to capture errors in its systems that were used to generate its short-interest reports.
The NYSE Hearing Panel Decision (HPD No. 06-053) notes Lehman’s representations to NYSE Enforcement that the firm has implemented new procedures to, among other things, pre-test the short-interest data before reporting. In settling these charges brought by NYSE Regulation, Inc., Lehman Brothers Inc. neither admitted nor denied the charges.
About NYSE Regulation, Inc.
NYSE Regulation, Inc., is a not-for-profit corporation dedicated to strengthening market integrity and investor protection. A subsidiary of NYSE Group, Inc., NYSE Regulation’s board of directors is comprised of a majority of directors unaffiliated with any other NYSE board. Each director must also be independent from member organizations and listed companies. As a result, NYSE Regulation is independent in its decision-making.NYSE Regulation protects investors by regulating the activities of member organizations through the enforcement of marketplace rules and federal securities laws. NYSE member organizations hold 98 million customer accounts or 84 percent of the total public customer accounts handled by broker-dealers. Total assets of NYSE member organizations are over $4 trillion. They operate from 20,000 branch offices around the world and employ 195,000 registered personnel. NYSE Regulation also ensures that companies listed on the NYSE and on NYSE Arca meet their financial and corporate governance listing standards.
NYSE Regulation consists of four divisions: Market Surveillance, Member Firm Regulation, Enforcement and Listed Company Compliance, as well as a Risk Assessment Unit and Dispute Resolution/Arbitration. For more information, visit our website at www.nyseregulation.com.
