FINRA and Nasdaq Fine Wedbush Securities Inc. $675,000 For Supervisory Violations Relating to Chronic Fails to Deliver by a Client in Multiple Exchange-Traded Funds
WASHINGTON — The Financial Industry Regulatory Authority (FINRA) and The Nasdaq Stock Market LLC (Nasdaq) announced today that they jointly censured and fined Wedbush Securities Inc. $675,000 for supervisory violations in connection with its handling of a client’s redemption activity and trading of leveraged exchange-traded funds (ETFs) that led to chronic fails to deliver in several ETFs for over two years.
Wedbush served as the clearing firm for its broker-dealer customer, Scout Trading, LLC, and acted as an Authorized Participant of various ETFs. This enabled Wedbush to submit redemption/creation orders on Scout Trading’s behalf and on behalf of its other clients. From January 2010 to March 2012, Scout Trading routinely submitted “naked” redemption orders in ETFs to Wedbush, meaning Scout Trading was insufficiently long in the ETF shares comprising the redemption orders. During the review period, Scout Trading submitted at least 255 naked redemption orders through Wedbush in 11 ETFs, totaling over 295 million shares. This naked redemption activity, along with short selling of the ETFs on the secondary market by Scout Trading, resulted in substantial, repeated fails to deliver by Wedbush. Scout Trading submitted creation orders, used to create new shares of the ETFs, through Wedbush to close out the fails to deliver; however, Scout Trading, shortly thereafter, submitted further naked redemption orders, or engaged in additional secondary market selling activity in the ETFs, through or with the assistance of Wedbush, that led to fails to deliver redeveloping at Wedbush. This pattern of naked redemption orders followed by creation orders resulted in persistent and sustained fails to deliver at Wedbush, and was profitable but impermissible.
Wedbush repeatedly effectuated Scout Trading’s ETF orders without first ascertaining whether Scout Trading owned, or had full legal and beneficial right to tender for redemption, the requisite number of ETF shares associated with its orders, contrary to its obligations as an Authorized Participant, and without taking sufficient follow-up actions concerning Scout Trading’s systemic and cyclical fails to deliver. As such, Wedbush failed to observe high standards of commercial honor and just and equitable principles of trade, and failed to meet its supervisory obligations to ensure that its activities as an Authorized Participant, including its processing of ETF orders, complied with applicable securities laws and regulations.
Thomas Gira, FINRA Executive Vice President and Head of Market Regulation, said, “Timely delivery of securities is a critical component of sales activity in the markets, particularly in ETFs that rely on the creation and redemption process. Naked trading strategies that result in a pattern of systemic and recurring fails flout such principle and do not comply with Regulation SHO. Authorized Participants and their broker-dealer clients need to have adequate supervisory procedures and controls in place to ensure that they are properly redeeming and creating shares of ETFs.”
John Zecca, Senior Vice President of Market Regulation for Nasdaq’s U.S. Markets, continued, “Authorized Participants, as gatekeepers and conduits to the primary ETF markets, play vital roles in ensuring they carry out their obligations consistent with applicable securities laws and do not become a vehicle for misconduct. We will continue to monitor firms for adherence to Regulation SHO and adequate supervisory systems to ensure such compliance.”
In concluding this settlement, Wedbush neither admitted nor denied the charges, but consented to the entry of FINRA’s findings. Scout Trading, which was a member of Nasdaq but not FINRA, was the subject of a separate Nasdaq disciplinary proceeding on April 7, 2015, in which it consented, without admitting or denying the charges, to the entry of findings by Nasdaq that Scout Trading violated Rule 204 of Regulation SHO and Nasdaq’s requirements that pertain to supervision and just and equitable principles of trade. That settlement resulted in a censure and $3 million fine against Scout Trading, a former Nasdaq member.
Investors can obtain more information about, and the disciplinary record of, any FINRA-registered broker or brokerage firm by using FINRA's BrokerCheck. FINRA makes BrokerCheck available at no charge. In 2015, members of the public used this service to conduct 71 million reviews of broker or firm records. Investors can access BrokerCheck at www.finra.org/brokercheck or by calling (800) 289-9999. Investors may find copies of this disciplinary action as well as other disciplinary documents in FINRA's Disciplinary Actions Online database. Investors can also call FINRA's Securities Helpline for Seniors at (844) 57-HELPS for assistance or to raise concerns about issues they have with their brokerage accounts and investments.
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