Article: FINRA Fines Merrill Lynch $6 Mln for Failing to Prevent Naked Short Selling

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FINRA Fines Merrill Lynch $6 Mln for Failing to Prevent Naked Short Selling

Victor Golovtchenk, 28 October 2014

According to an announcement by the U.S. Financial Industry Regulatory Authority (FINRA), U.S. bank Merrill Lynch’s Professional Clearing Corp. (Merrill Lynch PRO) got fined $3.5 million for violating Regulation SHO. The Securities and Exchange Commission (SEC) implemented this rule in 2005 to prevent the conducting of a practice called naked short selling.

Merrill Lynch’s affiliated broker-dealer Pierce, Fenner & Smith Incorporated (Merrill Lynch) has also been fined $2.5 million for failing to establish, maintain and enforce supervisory systems and procedures related to Regulation SHO and other areas, according to the FINRA announcement.

The practice of naked short selling is a particular form of selling shares short, without actually owning them in any form beforehand. Normally, when a short sale happens the party placing the trade is required to borrow the shares from another counterpart and buys them back at a later stage to return their debt.

In the real world, naked short selling doesn’t constitute much pressure on the price of a share. While the regulators would like to show off their work and stress to the public that negative share price developments are largely caused by speculators, reality can’t be further from the truth.

When a naked short sale is conducted, the party selling short owes the shorted shares to the buyer but instead “fails to deliver”. Such trades are almost exclusively conducted by market makers on the options market, as they are required to maintain liquidity in the set market.

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