Source: Securities and Exchange Commission
The Securities and Exchange Commission and the NYSE Regulation today settled separate enforcement proceedings against a prime broker and clearing affiliate of The Goldman Sachs Group for its violations arising from in an illegal trading scheme carried out by customers through their accounts at the firm.
Both proceedings find that firm customers traded and profited by illegally selling securities short just prior to public offerings of the companies' securities. In connection with the illegal short sales, the SEC and the NYSE found that the affiliate, Goldman Sachs Execution and Clearing L.P. (Goldman), violated the regulations requiring brokers to accurately mark sales long or short and restricting stock loans on long sales. The SEC and the NYSE further found that, if Goldman had instituted and maintained appropriate procedures, it could have discovered through its own records the customers' illegal activity.
The SEC Order and the NYSE's Decision allege that Goldman's customers carried out the illegal short-selling scheme by placing their orders to sell through the firm's REDI System - Goldman's direct market access, automated trading system - and falsely marking the orders "long." Relying solely on the way its customers marked their orders, Goldman executed the transactions as long sales. In addition, because the customers had sold the securities short and did not have the securities at settlement date, Goldman delivered borrowed and proprietary securities to the brokers for the purchasers to settle the customers' purported "long" sales. Both the SEC Order and the NYSE Decision find that, as described in the Order and Decision, Goldman's exclusive reliance on its customers' representations that they owned the offered securities was unreasonable.
Linda Chatman Thomsen, Director of the SEC's Division of Enforcement, said, "Customers now have direct market access platforms such as REDI and other automated trading systems, which enable brokers to execute larger volumes of trades more quickly and efficiently for their customers. However, as this case makes clear, direct access does not obviate a broker's own responsibilities under the Commission's short sale rules, and it certainly does not allow a broker to ignore apparent discrepancies indicating illegal trading by its customers."
David Nelson, Regional Director of the SEC's Southeast Regional Office in Miami said, "A broker must have a reasonable basis to believe its customers' representations that they own the securities they are selling. If, as in this case, there are significant trading disparities indicating that a customer may be lying to the broker, the broker must investigate the customer's trading and review its trading records to determine whether it can reasonably continue to rely on the customer's representations."
Susan Merrill, Executive Vice President of Enforcement, NYSE Regulation, said, "Blind reliance on customer representations that the customer is long the securities being sold is inappropriate when a firm is confronted with a customer's repeated failures to deliver and other evidence of improper short selling."
The SEC's Order and the NYSE Decision against Goldman find that for more than two years, beginning in March 2000, the customers' pattern of trading and Goldman's own records reflected that they were selling the securities short in violation of Rule 105 and Rule 10a-1(a). The customers did not deliver to Goldman in time for settlement the securities they purported to sell long, but rather, had to borrow the securities from Goldman to settle all of their sales. Goldman's records also reflected that its customers covered their short positions with securities purchased in follow-on and secondary offerings after executing their sales. Had Goldman instituted and maintained procedures reasonably designed to detect these significant trading disparities, it could have discovered the pattern of unlawful trades by its customers.
The SEC Order and NYSE Decision find that as a result of its failure to investigate the disparity between its customer's trading and the "long" designations on their sales orders, Goldman violated the Commission's short sale rules directly by allowing its customers to mark their orders "long" and lending them borrowed and proprietary securities to settle their sales. The order and decision also find that Goldman was a cause of its customers' violations of the short sale rules. The NYSE Decision further finds that Goldman failed to reasonably supervise its business activities.
The SEC Order and the NYSE Decision censure Goldman for its conduct and compel the firm to pay $2 million in civil penalties and fines. The SEC Order also directs Goldman to cease and desist from committing or causing any violations or future violations of Section 10(a) of the Securities Exchange Act of 1934 and Rule 10a-1(a), thereunder, and Rules 200(g) and 203(a) of Regulation SHO. (Rules 200(g) and 203(a) of Regulation SHO replaced Rule 10a-1(d) and Rule 10a-2, respectively, in January 2005.) Goldman consented to the order and decision without admitting or denying the findings made by the SEC or the NYSE. In determining to accept Goldman's offers of settlement, the SEC the NYSE considered remedial measures taken by Goldman.
The SEC previously brought a settled civil injunctive action against two of Goldman's customers who had engaged in the illegal short sales and who, pursuant to the settlement, paid over $1 million in disgorgement and civil penalties.