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Goldman Sachs Pay Penalty For NSS - it happens...

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Regulators Settle with Goldman Sachs Affiliate
By Aaron Seward
April 5, 2007

For the first time, the SEC and NYSE Regulation have teamed up and settled a suit against a prime broker for allegations of “naked” short selling when Goldman Sachs Execution and Clearing agreed to pay $2 million in civil penalties.

The two regulators accused the Goldman Sachs affiliate of allowing customers to conduct illegal short sales through its direct market access trading system. Naked short selling is the trading practice that involves trading borrowed shares without having first borrowed them.

According to the regulators, between March 2000 to 2002, Goldman carelessly allowed customers to incorrectly mark their sales “long” through the company’s REDI system, an automated, direct access trading system. Goldman didn’t check the customers’ representations against their records, but took them at face value and executed the sales.

The customers didn’t own the securities they were short selling at the settlement date, so Goldman wound up executing “naked” short sales by sending borrowed and proprietary securities to the brokers.

“If 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,” said David Nelson, Regional Director of the SEC’s Southeast Regional Office in Miami.

Goldman’s records also showed that its customers covered their short positions with securities purchased in follow-on and secondary offerings after executing their sales. Had Goldman put procedures in place to detect trading disparities it could have discovered the pattern of unlawful trades by its customers, the regulators said.

The SEC also said, that other firms need to show additional vigilance in dealing with direct access trading systems, which allow brokers to execute larger volumes of trades.

“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,” said Linda Chatman Thomsen, director of the SEC’s Division of Enforcement.

The regulators found that 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 without adequately investigating the transactions. They also blamed Goldman for their customers’ violations of the short sale rules. The NYSE took a step further, claiming that Goldman failed to reasonably supervise its business activities.

In addition to the fine, Goldman consented to the Commission’s cease and desist order, agreeing to take steps to avoid future violations of the securities laws. Goldman neither admitted nor denied the regulators’ allegations in making the settlement.

The case was initiated after two Goldman customers who allegedly engaged in illegal short sales settled charges with the SEC. Ethan Weitz and Robert Altman agreed to pay $1 million in disgorgement and civil penalties for short selling in advance of 15 stock sales.

Federal securities laws prohibit such trading on the basis that it can manipulate stock prices.