BGC's Lack of Oversight: A Gateway to Potential Naked Shorting? FINRA's Penalty? While not admitting or denying the findings, a censure, and a $50,000 fine...

https://www.finra.org/sites/default/files/fda_documents/2018060678201%20BGC%20Financial%20L.P.%20CRD%2019801%20AWC%20lp.pdf

Good evening Superstonk! I would like to share some more FINRA 'discipline' with y'all. As these releases convey a ton of information I am going to try a bit of a different approach, I hope this format makes sense.

• First, I am going to outline what BGC did in points from the filing.
• Next, I am going to pull the rules they broke and attempt to provide wut mean definitions
• Third, I am going to try and break each section against BGC down a bit further.

Let's hit it!

Outline of the violations BGC is being "disciplined" for while not admit or denying the findings:

1. From September 2010 to February 2019, the firm failed to include two proprietary accounts in calculations of the firm’s overall net position in equity securities (e.g., “short” or “long”) being sold, which ultimately caused certain orders to be mismarked under Regulation SHO Rule 200(g).
2. This occurred because the firm aggregated the accounts into independent trading units, even though the firm did not create a written plan of organization that identified the aggregation units, specified their trading objectives, and supported their independent identities, pursuant to Regulation SHO Rule 200(f)(1).
3. The firm also failed to establish, maintain, and enforce a supervisory system reasonably designed to achieve compliance with Rule 200(f) and (g), in violation of FINRA Rules 3110 and 2010, and NASD Rule 3010.

The Rules BGC broke:

Wut mean?

Imagine that your school is a big playground where kids trade baseball cards, and the principal is in charge of making sure that all trades are fair. To keep track of everything, the principal has made some rules.

Regulation SHO Rule 200(g) is like a rule saying that whenever a student wants to trade (or sell) a baseball card, they have to mark it as "short", "long", or "short exempt" based on their overall collection. This would mean:

• "Short" would be like a student promising to trade a baseball card they don't yet have, but they plan to get it soon, maybe from another trade.
• "Long" would be like a student trading a card they actually have in their collection.
• "Short exempt" would be a special scenario where a student promises a card they don't have, but for some reason, the rule about short selling doesn't apply.

Now, how do students know whether they're short or long? They'd look at their net position. That's where Rule 200(f) comes in. It's like a rule saying that each student has to count all the cards they have and the cards they've promised to others in their trades.

However, the school has clubs or groups (independent trading units) of students who, rather than trading individually, pool their cards together and trade as a group. These groups can count their cards together only if:

1. They've written down the club's purpose, who's in it, and why it's separate from other clubs.
2. The club keeps track of its net position for every type of card they trade.
3. All members of the club stick to the club's trading plan and don't coordinate with other clubs.
4. Each student is only a part of one club at a time.

If a student or a club doesn't follow Rule 200(g) or 200(f), they're also breaking the school's overall rule of fairness, the FINRA Rule 2010. This is like the principal's rule that every student, in all their dealings, must act honestly and fairly. Any student not following this principle would be in trouble with the principal.

Now, FINRA Rule 3110 and its predecessor NASD Rule 3010 are like the school's rules that say every club or group of students (member firms) need to:

(a) Create and maintain a system (like a club charter or a set of rules) to keep an eye on each club member's trading activities (activities of each associated person). This system needs to be well-designed to ensure that everyone is following the school's rules (compliance with applicable securities laws and regulations, and with applicable FINRA rules).

(b) Also, clubs need to establish, uphold, and enforce written procedures to supervise their type of trading (the types of business in which it engages) and the activities of its members. This is like each club having a club president or overseer who ensures that everyone is trading fairly, sticking to the rules, and not cheating or causing trouble.

If any club or student breaks either Rule 3110 or Rule 3010, they're also breaking the school's overall fairness rule, the FINRA Rule 2010, which is like the principal's rule that every student, in all their dealings, must act honestly and fairly. So, any club or student not following these rules would be in trouble with the principal. This would be like a violation of FINRA Rule 2010 in the financial world.

Diving into what BGC did furtherBGC inaccurately calculated its net position and mismarked orders:

During the period September 2010 to February 2019, the firm organized two of its proprietary accounts—the International Market Making Desk and the Mint Cash Equities Desk (ADR Desk)—into independent aggregation units for order-marking purposes. BGC’s order management system thus aggregated each desk’s positions within the desk’s respective unit—as would have been required by Regulation SHO Rule 200(f) if the desks had met the requirements for independent trading unit aggregation—instead of across the entire firm. This resulted in BGC’s order management system excluding the positions of these desks when calculating the firm’s net position in securities. The firm, however, failed to comply with the requirements of Regulation SHO Rule 200(f) regarding independent trading unit aggregation. Specifically, the firm failed to create a written plan of organization that identified the aggregation units, specified their trading objectives, and supported their independent identities, pursuant to Regulation SHO Rule 200(f)(1). As a result, the International Market Making Desk and ADR Desk did not qualify for independent treatment, and BGC’s order management system incorrectly excluded their positions when calculating the firm’s net position in securities, resulting in the firm mismarking trades for a portion of the review period.

Therefore, Respondent violated Regulation SHO Rule 200(f) and (g) and FINRA Rule 2010.

Wut mean?

From September 2010 to February 2019, a firm (BGC) split two of its own trading accounts - the International Market Making Desk and the Mint Cash Equities Desk (ADR Desk) - into separate trading groups.

• These groups were meant to keep track of their trades separately, like in the game rules of Regulation SHO Rule 200(f).

However, BGC messed up, they didn't follow the rules right.

• Specifically, they didn't make a proper game plan that detailed what these groups were, what their trading goals were, and why they were distinct from each other.

Because of this, these trading desks didn't qualify to be treated as independent groups.

• This resulted in BGC's system mistakenly not counting these desks' trades when tallying up the firm's overall position in the market.
• So, for a part of this period, BGC mismarked trades.
• In essence, BGC broke the rules - specifically, Regulation SHO Rule 200(f) and (g), and FINRA Rule 2010. In the eyes of the rule-makers, this is a big no-no.
• It's like a player not following the agreed game rules, giving them an unfair advantage, and messing with the integrity of the game.

BGC failed to establish, maintain, and enforce a supervisory system reasonably designed to achieve compliance with Regulation SHO:

From September 24, 2010, to February 1, 2019, the firm did not take any steps to verify that its order management system was achieving compliance with Regulation SHO. For example, the firm did not conduct regular order-marking reviews. In addition, BGC’s written supervisory procedures (WSPs) did not contain descriptions of any process to ensure compliance with Rule 200 and did not identify any individual responsible for such compliance.

Following FINRA’s cycle examination, the firm undertook an internal audit of its trading desks, implemented new procedures for reviewing order marking, revised its WSPs, and modified its procedures to include written plans of organization for the desks.

Therefore, Respondent violated NASD Rule 3010 and FINRA Rules 3110 and 2010.

Wut mean?

Between September 24, 2010, and February 1, 2019, the firm (BGC) really dropped the ball.

• They didn't take steps to make sure their trading system was following the rules of the game, specifically Regulation SHO. For instance, they didn't regularly check how they were marking orders.

Plus, their rulebook (written supervisory procedures or WSPs) didn't even have any guidelines on how to ensure they were following Rule 200.

• They also didn't have anyone in charge of making sure the rules were followed.

Only after FINRA came to check on them, they started to clean up their act.

• They did an internal check of their trading desks, set up new procedures for checking their order marking, updated their rulebook, and added the required written plans for their trading desks.
• This is akin to playing a game without checking the rulebook, then only realizing you're doing it wrong when someone points it out.

Okay, let's break this down for GameStop and the possibility of illegal naked shorting.

In a normal short sale, you borrow shares, sell them, and hope to buy them back cheaper to make a profit. But in a naked short sale, you sell shares you haven't borrowed, which can lead to more shares sold than actually exist. This is typically illegal because it can manipulate the market by artificially increasing the supply of the stock, driving down the price.

BGC's actions described above might create an environment where such illegal activities could take place for a few reasons:

1. Lack of Supervision: The firm (BGC) did not properly supervise or monitor its trading, and its system didn't correctly keep track of whether it was actually "short" or "long" on a stock. This means that it could potentially have been selling shares it didn't have (naked shorting) without even realizing it.
2. No Independent Validation: The firm did not have any process to ensure it was following Rule 200 (which is about marking orders as "short", "long", or "short exempt"). Without this, there's no way to make sure that the shares being sold short were actually borrowed.
3. Mis-marking Trades: The firm's system was incorrectly excluding certain trades when calculating the firm's net position in securities. If this included GameStop shares, it could make it look like the firm had more shares than it actually did, potentially allowing for illegal naked shorting.
4. Lack of Written Plan: The trading desks did not have written plans that specified their trading objectives and their independent identities. This lack of clear definition and objectives could contribute to a chaotic trading environment where illegal activities like naked shorting could take place.

For 'giggles' from their audit by EY:

https://www.sec.gov/Archives/edgar/data/825904/000082590419000002/BGCFBSOnlyYE.pdf

https://www.sec.gov/Archives/edgar/data/825904/000082590419000002/BGCFBSOnlyYE.pdf

"Penalty"?

while not admit or denying the findings, a censure and a $50,000 fine...

TLDRS:

From 2010 to 2019, BGC, a trading firm, didn't play by the rules when trading stocks.

• They didn't properly monitor their own trades, failed to check if their trading system was following market regulations, and they didn't have anyone responsible for ensuring rule compliance.
• Their playbook (WSPs) didn't include any plans or procedures to follow regulations properly.
• This sloppy operation created an environment where some fishy stuff could have potentially happened, like illegal naked shorting.
• Without proper checks and balances, BGC could've been selling shares they didn't own (naked shorting), and their system could've been mis-marking trades, making it seem like they held more shares than they actually did.
• Penalty? While not admit or denying the findings, a censure and a $50,000 fine...

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