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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:

  1. Implement Robust Supervisory Systems: Firms must establish and implement surveillance and review mechanisms to proactively monitor compliance with the Locate Requirement. 

  2. 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.

  3. 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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RIAs

The SEC recently brought settled enforcement actions against two registered investment advisers for failing to establish, maintain, and enforce written policies and procedures reasonably designed to prevent the misuse of material nonpublic information (MNPI), in violation of Section 204A of the Investment Advisers Act of 1940 (Advisers Act) and the Compliance Rule.

RIAs

On Sep. 4, 2024, FinCEN published a final rule (Final Rule) adding certain RIAs and ERAs (collectively, Covered Advisers) to the definition of “financial institution” under the regulations implementing the BSA, and imposing on Covered Advisers broad AML and CFT program requirements, as well as other BSA recordkeeping and reporting requirements.

Broker-Dealers

On November 22, the SEC announced (here) that broker-dealers Webull Financial LLC, Lightspeed Financial Services Group LLC, and Paulson Investment Company, LLC agreed to settle charges that they filed with law enforcement SARs that failed to include required information.

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© 2024 InnReg LLC

1101 Brickell Avenue
South Tower, 8th Floor
Miami, FL 33131

LinkedIn Innreg
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Quora Innreg
Blog Innreg

© 2024 InnReg LLC

1101 Brickell Avenue
South Tower, 8th Floor
Miami, FL 33131