FINRA Fines Cantor Fitzgerald $2 Million for Regulation SHO Violations and Supervisory Failures

It’s bad enough to get a regulatory fine, but to add insult to injury, what if you had to hire a supervisory “babysitter” to oversee your compliance operations?

That’s what happened to Cantor Fitzgerald & Co. The Financial Industry Regulatory Authority (FINRA) fined Cantor Fitzgerald $2 million for Regulation SHO (Reg SHO) violations and supervisory failures spanning a period of at least five years. Moreover, as part of the settlement, Cantor also agreed to retain an independent consultant to conduct a comprehensive review of the firm’s policies, systems, procedures and training related to Reg SHO.

Bad SHO and poor oversight

The Securities and Exchange Commission adopted Reg SHO to address concerns regarding persistent failures to deliver and potentially abusive “naked” short selling, e.g., the sale of securities that an investor does not own or has not borrowed. The rule requires firms to deliver the shares on the settlement date or take affirmative action to close out the “failure to deliver” shares by purchasing or borrowing the securities.

If the failure to deliver is not closed out, the firm may not accept additional short sale orders in the security without first borrowing or arranging to borrow the security.

Cantor compliance did not keep up with growth

FINRA discovered that from January 2013 through December 2017, Cantor’s supervisory system, including its written supervisory procedures (WSPs), was not reasonably designed to achieve compliance with the requirements of Reg SHO. Cantor’s use of a predominantly manual system to supervise its Reg SHO compliance was considered not reasonable in light of the firm’s business expansion and increased trading activity – from 35 billion shares in 2013 to 79 billion shares in 2014. Also, Cantor’s compliance personnel identified red flags in 2013, 2014 and 2015 indicating that the firm had systemic issues with Reg SHO and that its supervisory systems were not reasonably tailored to its business.

While Cantor made some changes, it did not adapt and enhance its supervision to address the deficiencies its personnel identified, commit additional staffing to monitor its compliance with Reg SHO or implement WSPs relating to its new lines of business until 2016.

Moreover, Cantor’s enhancements to its supervisory systems and procedures were not fully effective. For example, the firm failed to identify fails-to-deliver in accounts that were not monitored by its supervisory systems.

A history of noncompliance

Given Cantor’s prior disciplinary history relating to Reg SHO, FINRA also found that Cantor failed to timely remediate issues identified by its personnel. As a result, the firm did not timely close-out at least 4,879 fails-to-deliver, and routed and/or executed thousands of short orders in those securities without first borrowing (or arranging to borrow) the security or issuing notice of the need for a pre-borrow to the broker-dealers for whom it cleared and settled trades.

“As our Annual Examinations Priorities letter makes clear,” said Susan Schroeder, FINRA Executive Vice President, Department of Enforcement, “firm’s compliance with Regulation SHO is a continued focus…when evaluating operational risk…Firms need to ensure that their supervisory systems are reasonably tailored to their business and once they become aware of deficiencies in their supervisory systems, they must promptly remediate them.”

In determining the sanctions imposed, FINRA considered Cantor’s prior disciplinary history relating to Reg SHO, that the misconduct occurred over approximately a five-year period, the firm’s failure to address red flags in a timely manner, the continuing supervision deficiencies, as well as the firm’s efforts to improve its supervisory systems.

Okay, it’s only $2 million, but…wouldn’t compliance be so much cheaper?

Of course, it would. But negligent oversight or…deliberately bad actors aside – compliance is always cheaper. And we should know. At Patrina, we’ve built our business based on helping organizations stay on the “straight and narrow” efficiently and cost-effectively. So, let’s talk. Call 212-233-1155 to ask about Patrina’s cost-effective, designated third-party services, our comprehensive, 8-module compliance solution, and compliant data capture, file storage, and records archiving specifically designed for the financial services community. Be smart. Be covered.