Regulators are clamping down on broker-dealers that violate naked short-sale rules. Both New York Stock Exchange Regulation and the Financial Industry Regulatory Authority are making it a point to closely scrutinize brokers’ stock-loan practices. If they find brokers are not complying with rules targeting failures to deliver, they are penalizing them.
Duncan Niederauer, NYSE Euronext’s chief executive, told NYSE issuers in a letter this week that the NYSE has “impressed upon the SEC the importance of strictly enforcing the borrowing and delivery statutes tied to short selling, which have been unevenly enforced in the past.”
Thomas Gira, executive vice president and head of market regulation at FINRA, speaking at an Investment Company Institute conference this week, said FINRA has launched sweeps to see how well firms have complied with the Securities and Exchange Commission’s emergency orders covering naked short sales and the outright temporary ban on shorting nearly 1,000 financial securities.
The SEC issued emergency orders on Sept. 17, effective the next day, forcing brokers to close out any naked short positions still open one day after settlement or suffer the consequences. The emergency rule expired Oct. 17, but then became permanent as an “interim final rule.” That means it is still open for public comment.
FINRA has been policing naked short-sale trades all year. It has fined several firms, including Deutsche Bank Securities, Credit Suisse Securities, UBS, Susquehanna and Oppenheimer & Co.
The violations ranged in their severity. The most egregious were due to failures to deliver securities by settlement date. FINRA found that Oppenheimer, Credit Suisse and Deutsche Bank were not closing out certain fail-to-deliver positions within the required 13 consecutive settlement days. That rule applies to positions in “threshold securities,” which are stocks sold short of which a large number of shares have not been delivered.
Not borrowing stock was next on the list. FINRA found that Oppenheimer had either accepted short-sale orders from customers or effected their own short sales without borrowing the stock or entering into “bona fide” arrangements to borrow the stock. It also did the trades “without reasonable grounds to believe that the security could be borrowed,” so as to be able to deliver the shares on time.
Finally, the regulator found that one firm, Susquehanna, had accepted customer short-sale orders without confirming that they would receive delivery of the security, or that the firm could borrow the security on the customer’s behalf for delivery by the settlement date. FINRA noted that none of the executions of these orders resulted in a failure to deliver.
Fines for the specific violations are around $10,000.
Dealing with naked short-selling, or shorting stock without first borrowing it, has been at the top of the SEC’s to-do list this year. Pressure from issuers, the public and Congress led the SEC to push through rule changes that go a long way toward eliminating the practice.
According to Niederauer, the rules are not perfect. “While these rules cannot address the issue around intraday naked short selling entirely,” the executive said in his letter, “I do believe that strict adherence should prove effective at mitigating volatility if comprehensively enforced.”
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