FINRA, Nasdaq Fine Wedbush on Naked Trading in Leveraged ETFs

"Timely delivery of securities is a critical component of sales activity in the markets, particularly in ETFs that rely on the creation and redemption process," Thomas Gira, FINRA executive vice president and head of market regulation, said in a statement. "Naked trading strategies that result in a pattern of systemic and recurring fails flout such principle and do not comply with Regulation SHO. Authorized participants and their broker-dealer clients need to have adequate supervisory procedures and controls in place to ensure that they are properly redeeming and creating shares of ETFs."

Wedbush neither admitted nor denied the charges but consented to the entry of FINRA's findings. Scout Trading, which was a member of Nasdaq but not FINRA, was the subject of a separate Nasdaq disciplinary proceeding on April 7, 2015, in which it consented, without admitting or denying the charges, to the entry of findings by Nasdaq that Scout Trading violated Rule 204 of Regulation SHO and Nasdaq's requirements that pertain to supervision and just and equitable principles of trade. That settlement resulted in a censure and $3 million fine against Scout Trading, which is no longer a Nasdaq member.

According to FINRA, Wedbush repeatedly effectuated Scout Trading's ETF orders without first ascertaining whether Scout Trading owned, or had full legal and beneficial right to tender for redemption, the requisite number of ETF shares associated with its orders, contrary to its obligations as an authorized participant, and without taking sufficient follow-up actions concerning Scout Trading's systemic and cyclical fails to deliver. As such, Wedbush failed to observe high standards of commercial honor and just and equitable principles of trade, and failed to meet its supervisory obligations to ensure that its activities as an authorized participant, including its processing of ETF orders, complied with applicable securities laws and regulations. 

John Zecca, senior VP of market regulation for Nasdaq's U.S. Markets, added in the statement that "authorized participants, as gatekeepers and conduits to the primary ETF markets, play vital roles in ensuring they carry out their obligations consistent with applicable securities laws and do not become a vehicle for misconduct. We will continue to monitor firms for adherence to Regulation SHO and adequate supervisory systems to ensure such compliance."

— Check out SEC Fines Wedbush $2.4M in Market Access Case; FINRA Complaint on Deck on ThinkAdvisor.