2017 EXAMINATION FINDINGS REPORT
December 6, 2017
FINRA observed some instances in which firms have had difficulty meeting various aspects of their obligations under Regulation SHO and relevant FINRA rules:
- Supervision of Third-Party Order Management Systems – FINRA found that some firms may be overly reliant upon a third-party order management system for supervisory and compliance functions. FINRA noted inadequate levels of firm review and verification that third-party systems properly accounted for open sell orders as required by FAQ 2.5 concerning Regulation SHO and properly marked orders in accordance with Rule 200(g) of Regulation SHO.
- Trading Records From Third-Party Order Management Systems – Some firms were hindered from adequately conducting these supervisory reviews as a result of limitations with vendor-provided information and data and vendor non-responsiveness. FINRA found that some third-party vendors did not provide firms with trading records that would permit a review of order marking for compliance with Rule 200(g) of Regulation SHO and FAQ 2.5. Specific limitations that FINRA identified included: (1) firms that were unable to obtain trading records that provided proprietary order information (as opposed to trade execution information); (2) vendors that did not have a single report that captured proprietary order information; and (3) vendors that did not provide trading data in a format that firms could use to conduct testing and review for order marking (e.g., PDF documents that could not be converted to a more easily useable format).
- Locate Obligations – FINRA observed weaknesses in various aspects of certain firms’ locate practices. In some cases, firms continued to provide locates after depleting available shares, while in others there were weaknesses in some firms’ processes to document manual locates after available shares were depleted. FINRA also found that firms failed to establish proper controls to ensure that “easy to borrow” lists were accurate and updated timely to reflect current market or other conditions, such as existing fails to deliver or securities designated “hard to borrow.”
- Fail-to-Deliver Closeouts – FINRA observed instances where firms did not maintain adequate written supervisory procedures for complying with Rule 204 of Regulation SHO regarding closeout of fails to deliver. The procedures did not address, for example, actions to be taken when transactions in American Depository Receipts did not settle on the applicable settlement date or how firms would ensure their books and records are net flat or net long on a day when a closeout obligation existed.