Interactive Brokers LLC agreed to pay a fine of US $5.5 million to the Financial Industry Regulatory Authority to settle allegations that, from July 2012 through June 2015, it purportedly failed to comply with certain aspects of the Securities and Exchange Commission’s Regulation SHO, and failed to have and follow written supervisory procedures reasonably designed to detect such failures. Moreover, said FINRA, the firm failed to act on red flags of relevant failures, including internal audit findings and “multiple internal warnings” from the firm’s clearing and compliance departments.
IB is a broker-dealer licensed by the Securities and Exchange Commission and a member of FINRA.
Among other things, Reg SHO generally requires broker-dealers to close out short sales where delivery of the quantity of the relevant security has not occurred (a so-called “failed to deliver” or “FTD”) by borrowing or purchasing the same quantity of a like-kind security by the beginning of regular trading hours on the settlement day following the settlement date. (Click here to access SEC Rule 204(a), and here for 17 CFR 242.204(a).) The SEC claimed that, during the relevant time, IB failed to close out open FTDs on at least 2,329 occasions.
Moreover, Reg SHO also prohibits a broker-dealer from engaging in short sales in a security subject to an FTD without first borrowing or arranging to borrow the security. FINRA claimed that IB violated this requirement on approximately 28,000 occasions during the relevant time because its automated systems incorrectly gave credit for borrows that were not delivered and thus did not correct the FTD.
IB agreed to the FINRA settlement without admitting or denying any findings.
Compliance Weeds: Under Reg SHO (click here to access this regulation at 15 USC §§ 242.200 - 242.204), a broker-dealer accepting a short sale of an equity security from a customer (or engaging in a short sale in its own proprietary account) must first borrow the security, enter into a bona fide arrangement to borrow the security, or have reasonable grounds to believe the security can be borrowed before the delivery date. Broker-dealers comply with this so-called “locate requirement” by maintaining so-called “easy to borrow” lists, which set forth equity securities they reasonably believe they can borrow. Absent an authorized basis, brokers that are participants on a registered clearing agency must close out FTD transactions by no later than the beginning of trading on the settlement day following settlement day of the relevant securities (T+3). However, if the participant can demonstrate that a failoccurred from a long sale or is attributable to bona fide market maker activities, it must close out the relevant securities by no later than the beginning of trading on the third consecutive settlement following the settlement date (T+5). Many other very technical requirements may apply. (Click here for background regarding Reg SHO in an SEC publication, Key Points About Regulation SHO.)