FINRA Penalizes Broker-Dealer for Failing to Comply with Regulation SHO's Locate Requirement
Broker-Dealers
Compliance Operations
August 31, 2024
The Case
The Financial Industry Regulatory Authority (FINRA) recently took enforcement action against a broker-dealer for failing to adhere to the "Locate Requirement" under Rule 203(b)(1) of Regulation SHO. This regulation requires broker-dealers to either borrow securities or have reasonable grounds to believe that securities can be borrowed before executing short sales.
The firm was found to have incorrectly facilitated at least 10 million short sales based on locates obtained by its broker-dealer clients. Additionally, the firm’s Written Supervisory Procedures (WSPs) incorrectly indicated that the firm could rely on its clients’ locates without implementing any other supervisory system or review mechanism to follow the regulation.
Due to these violations, the firm has been censured and fined $250,000. Additionally, the firm must remediate its supervisory system and submit a written certification attesting to the effectiveness of the new procedures.
Regulatory Implications
This case highlights FINRA’s strict enforcement of Regulation SHO’s Locate Requirement, underscoring the importance of broker-dealers adhering to short sale regulations and maintaining adequate supervisory controls.
Since Rule 203(b)(1) mandates that broker-dealers must either borrow or have a bona fide arrangement to borrow securities before effecting short sales, failure to do so not only breaches Regulation SHO but also FINRA Rule 2010, which requires firms to observe high standards of commercial honor and principles of trade.
Practical Guidance for Firms
To avoid similar enforcement actions, broker-dealers are advised to review and update their supervisory procedures and systems related to short sales and the Locate Requirement.
Key considerations include:
Implement Robust Supervisory Systems: Firms must establish and implement surveillance and review mechanisms to proactively monitor compliance with the Locate Requirement.
Review and Update WSPs: Written Supervisory Procedures must accurately reflect the firm’s obligations under Regulation SHO. Firms should ensure that they cannot rely solely on clients’ representations for compliance with the Locate Requirement.
Conduct Regular Audits: Periodic reviews and audits of short-sale practices and compliance systems can help identify and correct deficiencies before they lead to regulatory violations.
Since 2013, InnReg has been a trusted compliance consulting provider, assisting firms in navigating regulatory requirements such as Regulation SHO.
Our tailored compliance solutions help broker-dealers develop and implement effective supervisory systems, reducing the risk of non-compliance and regulatory penalties.
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