SEC Fines BNP Paribas Securities for Violations of Regulation SHO

Regulation SHO requires firms to deliver the shares, after completion of a short sale transaction, on the settlement date.

The US top regulator has fined BNP Paribas Securities (BNPP) $250,000 for allowing a broker-dealer to violate ‘naked short selling’ rules at least 35 occasions over a four-month period.

From April 2016 through July 2016, according to the SEC, BNPP loaned securities to a hedge fund that was a client of its prime brokerage unit to settle their “long” sales. Although the sale orders were all executed away from BNPP at another broker-dealer, the company repeatedly ignored red flags of this client’s fails-to-deliver in a timely manner.

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The broker, however, continued to accept similar positions from the same client even after securities were not timely delivered to cover the sale. Instead, BNPP “automatically” loaned the hedge fund shares to settle these “long” sales and did not conduct any analysis or consider the hedge fund’s history of failing to deliver shares to its account prior to scheduled settlement.

As such, BNPP violated Regulation SHO and other related rules when it loaned the hedge fund, in total, more than eight million shares of three different issuers to settle “long” sales that were submitted for clearing.

During that period, BNP Paribas was aware of supervisory deficiencies but did not implement remedial measures, while it accepted and executed short orders in those securities without first borrowing (or arranging to borrow).

“Further, although the Hedge Fund routinely made assurances to BNPP that its orders were properly marked as “long” and that it would deliver the securities to its BNPP account prior to the settlement date, it was not reasonable for BNPP to rely on such representations because BNPP was on notice of the Hedge Fund’s repeated failures to deliver the securities to its BNPP account by settlement date,” the regulator said.

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The US broker-dealer arm of the French lender neither admitted nor denied the charges, but consented to the entry ‎of SEC’s findings.

SEC explains how it happened

Short selling – which allows investors to make gains in a falling market by borrowing a security they don’t own, selling it and agreeing to buy it back at a lower price – plays an important role in developed capital markets since it makes price discovery more efficient and smooths volatility whilst providing investors with a host of risk-management tools.

Regulation SHO requires firms to deliver the shares, after completion of a short sale transaction, on the settlement date or take affirmative action to close out the “failure to deliver” shares by purchasing or borrowing the securities. To limit ongoing naked short positions, the broker has no choice but to reject any additional sale orders if the securities were not delivered or closed out within legally required time frames.

Regulation SHO also prohibits the execution of short sales in covered securities at a price that is less than or equal to the best bid when the price of the security has fallen by 10 percent or more in one day.

The legal notice further explains how the “long” sale occurred; it reads:

“For example, in April 2016, BNPP loaned the Hedge Fund shares to settle “long” sale orders in one security on eight consecutive trading days. In June and July 2016, BNPP loaned the Hedge Fund shares to settle “long” sale orders in another security on 16 consecutive trading days. On at least 19 occasions, BNPP loaned securities to the Hedge Fund to settle “long” sale orders while the Hedge Fund had outstanding loans of the same securities, which it had borrowed to settle prior “long” sales that previously had been submitted to BNPP for clearing.”

 

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