The Financial Industry Regulatory Authority (FINRA) has fined New York's Deutsche Bank Securities with $575,000 and Boston's National Financial Services (NFS) with $350,000, for executing numerous short sale orders in violation of Regulation SHO and for related supervisory violations.
Regulation SHO requires that a broker or dealer may not accept or effect a short sale order in an equity security without reasonable grounds to believe that the security can be borrowed, so that it can be delivered on the date delivery is due. Identifying a source from which to borrow such security is generally referred to as obtaining a ‘locate’. Locates must be obtained and documented prior to effecting a short sale.
Both Deutsche Bank and NFS implemented direct market access trading systems for their customers that were designed to block the execution of short sale orders unless a ‘locate’ had been obtained and documented.
But FINRA found that Deutsche Bank disabled its system in certain instances and NFS created a separate system for certain customers, so that in both instances, the systems no longer blocked some short sale orders that did not have valid, associated locates.
In Deutsche Bank’s case, the firm’s systems sometimes experienced outages that prevented the importing of locate data and, as a result, short sale orders placed for execution were automatically rejected, even when a client had already obtained a valid and properly documented locate.
FINRA found that during these system outages, Deutsche Bank disabled the system’s automatic block, permitting client short sale orders to automatically proceed for execution without first confirming the presence of an associated locate.
The regulator also found that in addition to its automated process, NFS created a separate manual locate request and approval process for approximately 12 of the firm’s prime brokerage clients, which preferred to obtain locates in multiple securities prior to commencement of the trading day.
James Shorris, executive vice president and acting chief of enforcement at FINRA, said: “The locate requirement is an essential component of ensuring that short sales are executed properly. The failure to design, implement and supervise systems that reasonably ensure that shares of a security are available to be borrowed before a short sale is executed significantly undermines the effectiveness of Regulation SHO.”