The SEC has announced an agreement with Merrill Lynch to resolve charges that it violated Regulation SHO because its trade execution platforms used outdated easy to borrow lists in the short sale of securities. Merrill did not update its hard to borrow lists used by these computer programs during the business day, resulting in the use of data that was more than 24 hours old. Even when Merrill learned that a stock’s supply was restricted and its brokers updated their lists, it continued to allow trades by its customers in stocks through these programs as if they were easy to borrow.
The short sale of a stock, for those that aren’t familiar with the process, involves selling shares in stock that you do not own. The shares are borrowed from their actual owner and provided to the purchaser. The person who has sold short plans to buy them back in the market later and provide them to the owner who allowed his or her shares to be borrowed rather than the purchaser, who remains in possession of the owner’s original shares.
Normally, the borrowing happens behind the scenes at the clearing firm. But clearing firms are required to hold a percentage of their shares back from lending in case an actual owner wants to sell their shares. If too many of the shares in a stock have already been borrowed for short sale, then the stock may become hard to borrow. This typically requires the clearing company to find additional shares to borrow before a customer can sell them short.
Merrill’s trade platforms executed sales of 2.3 million shares of stock when it did not have sufficient securities in reserve to allow them to be borrowed. In the settlement with the SEC, Merrill admitted wrongdoing and agreed to pay $9 million in a civil penalty, a $1.6 million disgorgement and prejudgment interest.
The conduct at issue took place from 2008 to 2014. Merrill Lynch is a subsidiary of Bank of America.
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