These statistics show substantial increases in the amount of fines FINRA has imposed during the past three years in cases involving alleged violations of FINRA’s short selling rules. As the amount of fines assessed in short selling cases has grown during this time, these cases have represented an increasing percentage of FINRA’s overall fines.
Short selling placed second on Sutherland’s 2011 Top Enforcement Issues list with $16.8 million of fines. However, this was due largely to a single case that resulted in a $12 million fine (FINRA’s largest fine in 2011) for a firm’s alleged violations of Regulation SHO and corresponding supervisory deficiencies. Regulation SHO requires a seller to reasonably believe a security can be acquired and delivered before it may be sold short. It also requires sellers to mark the shares as either long or short. Brad Bennett, FINRA’s Chief of Enforcement, noted that the firm’s alleged behavior, which included making millions of short sales without a reasonable belief that the securities could be acquired and mismarking millions of short sales, “created a potential harm for the integrity of the market.” Mr. Bennett also warned firms that their trading and supervisory systems must be designed to “prevent potentially abusive naked short selling.”
Two other firms were each fined $900,000 for alleged short selling violations in 2011. In the first case, which was settled, a firm was sanctioned $900,000 for Regulation SHO charges similar to those described above. The firm allegedly released hundreds of short sale orders without first obtaining a “locate” (identifying the source from which the security will be borrowed) and documenting that the security could be acquired. FINRA also alleged that the firm did not properly train and equip personnel to locate securities that were the subject of short sales. Further, FINRA claimed there was a systemic failure to implement an effective framework for Regulation SHO compliance, including having incomplete and incorrect written policies regarding short sales. In the second case, which was litigated, FINRA expelled and barred Legacy Trading Co., LLC and its CEO and imposed a $900,000 fine against these respondents for “egregious” and “willful” violations of short selling rules. The firm was found to have executed nearly 2,200 short sales without making any effort to determine whether the security being sold could be borrowed. The hearing officer found that some short sales were executed although the respondents knew they violated SEC and FINRA rules.
The message from these three cases, and the growing amount of short selling fines, is clear: FINRA will be reviewing the thoroughness and effectiveness of firms’ supervisory systems and procedures relating to short sales and Regulation SHO.