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March 21 — Wedbush Securities Inc., the clearing firm for Scout Trading LLC, settled Financial Industry Regulatory Authority and Nasdaq Stock Market LLC allegations that it didn't properly handle a client's redemption activity and trading of leveraged exchange-traded funds.
The violations led to “chronic” failures to deliver a substantial number of shares in several ETFs for over two years, FINRA said in a March 21 release. The case is FINRA's first action against a firm for supervisory violations in connection with “naked” ETF redemptions.
Without admitting or denying wrongdoing, Wedbush consented to FINRA's findings and agreed to be censured and pay a $675,000 civil penalty.
According to FINRA, from January 2010 until March 2012, Scout Trading submitted approximately 255 “naked” redemption orders in 11 ETFs to Wedbush, totaling over 295 million shares. In a naked redemption, the firm doesn't have a big enough long position in the instruments.
Allegedly, Scout Trading submitted creation orders (to create new shares of the ETFs) through Wedbush to close out the failures to deliver. However, shortly thereafter, Scout Trading submitted additional naked orders or engaged in additional secondary market selling activity in the ETFs, through Wedbush, FINRA said. This activity, coupled with Scout Trading's short selling of the ETFs on the secondary market, resulted in profitable, but substantial failures to deliver by Wedbush, the self-regulatory organization said.
In executing the orders, FINRA alleged that Wedbush didn't meet its supervisory obligations because it didn't first determine whether Scout Trading actually owned the number of ETF shares associated with its orders.
Scout Trading, a former member of Nasdaq but not FINRA, was the subject of a separate April 2015 Nasdaq disciplinary proceeding arising out of the same transactions. It agreed to be censured and to pay a $3 million fine.
To view the Wedbush settlement correspondence, visit: http://disciplinaryactions.finra.org/Search/ViewDocument/64953.
To view the Scout Trading settlement correspondence, visit: http://www.nasdaqtrader.com/content/marketregulation/NASDAQ/DisciplinaryActions/SCOU_NQ_2015.pdf.
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