Recent Financial Industry Regulatory Authority (“FINRA”) findings reveal that Two Sigma Securities, LLC failed to comply with the Locate Requirement of Rule 203(b)(1) of Regulation SHO pursuant to the Securities Exchange Act of 1934. While not in any formal arrangement to borrow securities, Two Sigma Securities, LLC effected short sale transactions from March 21, 2014 to May 5, 2016.
On July 11, 2016, the firm reported itself to FINRA after discovering two system issues affecting its calculation of available securities to comply with the “locate requirement” under Rule 203(b)(1):
- the market-making aggregation unit’s overall net position was miscalculated, because the short and long positions of the legacy market-making strategy of its aggregation unit were omitted.
- Trade strategies failed to distinguish between threshold and non-threshold securities which resulted in the reapplication of locates “from earlier short sales to subsequent intra-day short sales in threshold securities.”
In short, Two Sigma Securities, LLC failed to reasonably supervise for Locate Compliance.
The firm’s supervisory system was not reasonably designed to satisfy the locate requirement. It never tested the accuracy of the current systems in place that were relied on that sole purpose. Also, no supervisory reviews were present to confirm that the data that was knowingly referenced in surveillance reports was in fact accurate.
Additionally, Two Sigma Securities, LLC’s Written Supervisory Procedures (WSPs) were not reasonable.
The firm lacked any WSPs regarding system changes, or updates. The firm’s WSPs did not even reference its “quality control process” and never confirmed if that process was indeed being followed. The procedures also never expressed that designated supervisors were responsible for reviews to deem any systems changes as reasonable, and failed to provide descriptions of the nature, scope, and use of the locate requirement surveillance reports.
There was little to no reason for the firm to believe that the securities could be borrowed for delivery on settlement date. Nevertheless, over 13 short sales “resulted in the failure to deliver of securities at the firm’s clearing firm.”
As a result of its violations of NASD Rule 3010 FINRA Rules 3110 and 2010, and Rule 203(b)(1) of Regulation SHO, Two Sigma Securities, LLC was censured and fined $225,000.