The Financial Industry Regulatory Authority (Finra) fined Deutsche Bank's New York securities business US$525,000 and Fidelity unit NFS US$350,000 for executing "numerous short sale orders" in violation of Regulation SHO and related supervisory violations.
Regulation SHO says that brokers or dealers cannot make a short sale without identifying a source from which to borrow the security. This is generally referred to as obtaining a "locate" and these must be obtained and documented before making a short sale.
Finra says both Deutsche Bank and NFS implemented DMA trading systems for their customers that were designed to block the execution of short sale orders unless a "locate" had been obtained and documented. Yet on several occasions Deutsche Bank disabled its system and NFS created a separate one for certain customers, meaning some short orders were not blocked.
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 says that during these outages, the bank disabled the system's automatic block, permitting client short sale orders to automatically proceed for execution.
Meanwhile, NFS created a separate manual locate request and approval process for around 12 prime brokerage clients. Requests for, and approvals of, the multiple simultaneous locates were transmitted via e-mail with account representatives on the firm's Prime Services Desk, and were not required to be entered into its stock loan system, says the watchdog.
Further, Finra says both firms supervisory systems were inadequate. Deutsche Bank was aware that its system to block short sale orders in the absence of locates was periodically disabled over a period of more than four years - from January 2005 through September 2009 - but failed to roll out a replacement. Similarly, NFS created a flawed system for certain customers that failed to ensure that some short sale orders had valid and timely locates for nearly four years - from January 2005 through August 2008).
James Shorris, acting chief of enforcement, Finra, says: "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."
