The Securities Lawyer Blog has previously posted on Regulation SHO and this past week, FINRA announced that another Reg SHO matter has been settled. UBS Securities LLC has agreed to pay $12 million in fines for the alleged violations. The firm also settled claims that it had failed to supervise securities short sales, something that was not detected by the firm until FINRA's investigation brought various alleged failures to light.
Among other things, Reg SHO provides for specific requirements for broker-dealers in short sale transactions. FINRA alleged that in the UBS matter, the broker-dealer's Reg SHO violations led to "millions of short sale orders" that were "mismarked and/or placed to the market without reasonable grounds to believe that the securities could be borrowed and delivered."
Specifically, since short sales involve the sale of securities that the seller does not own, Reg SHO protects the buyer in that it requires that the broker-dealer have reasonable grounds to believe the security involved in the short sale can either be purchased or borrowed at the time of delivery. The "reasonable grounds" must be present before the broker engages in the short sale and the broker should not accept the short sale order unless these reasonable grounds are present.
Under Reg SHO, broker-dealers are required to designate an equity securities sale as either long or short. It is intended to protect buyers from a potential failure of delivery of equity securities -- this is why the broker-dealer must secure and also document the "locate" information prior to the short sale.
Allegedly, UBS's supervision of these critical aspects of compliance with Reg SHO were lacking in that locates and marking of sale orders were not sufficiently monitored. This in turn led to Reg SHO failures in the firm's equity trading business which is the scenario that Reg SHO is intended to protect against.
Without locates at the time of the short sale order, the risk of failure is increased significantly. When selling securities that are difficult to borrow, this makes the likelihood even greater. That is one way in which FINRA alleged the UBS system was flawed. FINRA noted that the locate violations were found throughout the UBS system, stating that they "extended to numerous trading systems, desks, accounts and strategies."
The violations were also alleged to have extended to the firm's procedures and technologies, as well as its operations. UBS short sales orders were alleged also to have been mismarked as long, rather than short which violated the locate requirement in Reg SHO. UBS was also alleged to have had "significant deficiencies related to its aggregation units" which was suggested to have possibly resulted in the extensive order-marking and locate violations.
FINRA's investigation uncovered systems and a lack of supervisorial procedures for short sales in the UBS system prior to 2009, which it has had an opportunity to correct and redesign to ensure compliance with Reg SHO in the future.
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