Sutherland FINRA Focus #3: 2013 Short Selling

WASHINGTON--()--As reported on February 24, 2014 in Sutherland Asbill & Brennan LLP’s annual analysis of FINRA’s disciplinary actions, short selling cases generated the third-highest amount of fines for the regulator in 2013.1 This past year, FINRA reported $7.2 million in fines from 40 cases involving alleged short selling violations.2 This Sutherland FINRA Focus looks more closely at the regulator’s recent enforcement actions and examines a few of the key 2013 short selling cases. Short selling cases often involve allegations that the firm (1) executed short sales without having a reasonable belief that the securities could be borrowed or (2) reported trades without short sale modifiers.

The chart below shows the total number of short selling cases and fines FINRA has reported during each of the past six years.

 

FINRA’s Short Selling Sanctions Statistics, 2008–2013

        Fines

Reported

     

Percentage

Change

     

Percentage of

Total FINRA Fines

     

Cases

Reported

     

Percentage

Change

2008       $289,000       --       1%       7       --
2009       $2.5 million       765%       5%       28       300%
2010       $3.5 million       40%       8%       54       93%
2011       $16.8 million       380%       25%       38       (30%)
2012       $5.1 million       (70%)       7%       38       --
2013       $7.2 million       41%       13%       40       5%
 

These statistics show that short selling cases have been a significant area of regulatory emphasis for FINRA in recent years. Over the past five years, fines in short selling cases have made up approximately 12% of FINRA’s total fines. Unsurprisingly, short selling has often appeared in Sutherland’s Top Enforcement Issues list, generating the fifth highest amount of fines in 2010, second in 2011, and third in 2013.

Although short selling fines increased substantially in 2013, this was largely due to a single case that resulted in a $4 million fine.3 In addition to allegations about the firm’s supervision of direct market access and sponsored access trading, FINRA alleged that the firm violated Regulation SHO and two of the SEC’s 2008 Emergency Orders that restricted short sales of certain securities. FINRA asserted that the firm allowed its clients to submit many short sale orders for these restricted securities during the 2008 financial crisis. Additionally, FINRA alleged that the firm accepted short sale orders without having a reasonable basis that the securities could be borrowed. FINRA found that the firm did not have adequate supervisory procedures in place to ensure that its foreign affiliates that accessed U.S. markets through the firm were complying without Regulation SHO. FINRA also alleged that the firm knew of these issues, but did not fully correct them until three years later. In addition to FINRA’s $4 million fine, the firm was fined an additional $5.5 million by the BATS Exchange, the New York Stock Exchange, NYSE Arca, and NASDAQ. Thomas Gira, FINRA’s Executive Vice President of Market Regulation, noted that “this case also illustrates how FINRA and the exchanges can effectively pursue activity that spans multiple markets.”4

Two other significant short selling cases reported in 2013 demonstrate the importance of properly marking short sale trades. In one case, a firm was fined $265,000 after it allegedly executed and reported more than eight million cross transactions, which were also short sales, without including a short sale modifier.5 FINRA also asserted that the firm did not have proper procedures in place to help prevent this issue. FINRA fined another firm $250,000 in 2013 for allegedly leaving short sale indicators off some of the firm’s electronic “Blue Sheet” reports over a four-year period.6 FINRA stated that this issue occurred because some short sale information was not passed from the firm’s middle office system to the back office. FINRA noted that these allegations impacted only 360 short sale transactions, out of 121,000 total trades, over a four-year period, but still fined the firm $250,000. These two recent cases show that even administrative issues can lead to significant fines.

The substantial fines in these three cases, as well as the high level of enforcement activity in this area over the past five years, show that this is an important issue for FINRA. According to Brian Rubin, the head of Sutherland’s Securities Litigation and Enforcement Group, “short selling has been a key area for FINRA during the past several years, and we expect FINRA to continue to focus on these issues.”

1 Brian Rubin and Andrew McCormick, Annual Sutherland Analysis of FINRA Sanctions Shows 27% Decrease in Fines; Number of Cases Nearly Identical, Feb. 24, 2014, available at http://www.sutherland.com/NewsCommentary/Press-Releases/161244/Annual-Sutherland-Analysis-of-FINRA-Sanctions-Shows-27-Decrease-in-Fines-Number-of-Cases-Nearly-Identical. Sutherland FINRA Focus reports about electronic communications and trade reporting were released on February 25, 2014 and February 26, 2014, respectively.

2 The number of cases reported and the amount of corresponding fines come from the Disciplinary and Other FINRA Actions report that FINRA publishes each month. Many of these cases also involved other allegations, making it impossible to attribute the exact amount of any particular fine to a specific allegation.

3 FINRA New Release, July 11, 2013, available at http://www.finra.org/Newsroom/NewsReleases/2013/P299086.

4 Id.

5 FINRA AWC No. 2008013213201, Dec. 12, 2012 (reported by FINRA in February 2013).

6 FINRA AWC No. 2011027202401, Jan. 7, 2013.

Contacts

Sutherland Asbill & Brennan LLP
Brian L. Rubin, 202-383-0124
brian.rubin@sutherland.com

Release Summary

Sutherland Asbill & Brennan’s annual analysis of FINRA’s disciplinary actions finds that short selling cases generated the third-highest amount of fines ($7.2 million) for the regulator in 2013.

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Contacts

Sutherland Asbill & Brennan LLP
Brian L. Rubin, 202-383-0124
brian.rubin@sutherland.com