The SEC said that Merrill Lynch (MER) would pay $11 million to resolve allegations of short-selling-related noncompliance. The regulator said that the wirehouse executed short sales in certain securities when the supply for this type of transaction was restricted.
Customers frequently ask brokerage firms to “locate” stock that can be used for short selling. The financial firms generate easy-to-borrow lists made up of the stock they believe is accessible for such locates. However, contends the SEC, from January 2008 through January 2014 Merrill used information that was dated to create these ETB lists.
For example, there were times when certain securities that were placed on the ETB list in the morning were no longer as easily available for borrowing later in the trading day. Yet Merrill’s platforms were set up so that they continued to process short sale orders according to the now-dated list—even as firm personnel appropriately stopped using the list for sourcing locates when certain shares’ availability had become restricted.
The regulator cites an example in which lenders would tell Merrill personnel that a certain security wasn’t available for short selling anymore, but then its systems would keep using the ETB list and execute short sales involving thousands of shares for that security. The SEC also said that for a while, a problem in Merrill Lynch’s systems would occasionally cause the use of data that was a day old when an ETB list was generated.
This caused certain securities to be placed on the list when they shouldn’t have been. Ultimately, such inaccuracies allowed the firm’s trade-execution platforms to perform short sales of 2.3 million shares in securities that should not have been on the ETB lists due to low availability.
As part of the settlement, Merrill admitted to violating the Securities Exchange Act of 1934’s Regulation SHO Rule 203(b). It consented to pay a $9M civil penalty. It also agreed to a $1.6M disgorgement and $334,564 in prejudgment interest. It will retain an independent compliance consultant to examine its short sales practices, procedures, and polices.
A short sale involves the sale of a stock that does not belong to an investor or one in which a sale is fulfilled by the delivery of a stock borrowed by the investor or for the investor’s account. The investor closes out the position by returning the security it borrowed to the stock lender.
Broker-dealers usually lend stock to customers who take part in short sales. They do this by using their own investor or the margin account or another lender to do this. Short sellers have to abide by margin rules and other charges. If a dividend is reaped by the borrowed stock then the short seller has to pay that to the party that made the loan.
Investors who sell stock short usually think the stock price will drop so they can purchase it at the lower price and make a profit. Losses however can occur if the stock price goes up and the short seller made the purchase at that higher price.
Contact our investment fraud law firm if you suspect you were the victim of securities fraud.
Read the SEC Order (PDF)