Merrill Lynch agreed to admit wrongdoing, pay nearly $11m, and retain an independent compliance consultant in order to settle the charges.
According to the SEC’s order instituting a settled administrative proceeding, Merrill Lynch and other broker-dealers are routinely asked by customers to “locate” stock for short selling, and firms prepare easy-to-borrow (ETB) lists comprised of stocks they have deemed readily accessible for the purpose of granting locates. At times during the course of a trading day, some securities that Merrill Lynch placed on its ETB list that morning became no longer easily available to borrow as determined by lending desk professionals tracking market events and other daily developments.
The SEC’s order finds that Merrill Lynch personnel appropriately ceased using the ETB list to source locates when availability of certain shares became restricted, but the firm’s execution platforms were programmed to continue processing short sale orders based on the ETB list. For example, while personnel received responses from lenders that a supply of a particular security was no longer available, Merrill Lynch’s systems continued to rely on the ETB list and execute short sales totalling thousands of shares of that security. It wasn’t until the platforms received the next day’s ETB list that they returned to utilizing accurate and present data. After the SEC started investigating, Merrill Lynch began implementing systems enhancements to correct the problem.
“Firms must comply with their short-selling obligations by making sure they do not rely on inaccurate ETB lists,” said Andrew M. Calamari, Director of the SEC’s New York Regional Office. “When firm personnel determine that a security should no longer be considered easy to borrow, the firm’s systems need to incorporate that knowledge immediately.”
The SEC’s order further finds that for a period until 2012, a flaw in Merrill Lynch’s systems occasionally triggered the inadvertent use of day-old data when constructing ETB lists. The stale data caused some securities to be included on an ETB list when they should not have been.
Merrill Lynch admits violating Rule 203(b) of Regulation SHO of the Securities Exchange Act of 1934, and the SEC’s order requires the firm to cease and desist from committing or causing any future violations. Merrill Lynch agreed to pay a $9m penalty, $1,566,245.67 in disgorgement, and $334,564.65 in prejudgment interest. The independent compliance consultant must conduct a comprehensive review of the firm’s policies, procedures, and practices for accepting short sale orders for execution, effecting short sales in reliance on the ETB list, and monitoring compliance.