The Financial Industry Regulatory Authority and the Nasdaq Stock Market on Monday jointly censured and fined Wedbush Securities Inc. $675,000 for supervisory violations in connection with its handling of a client’s redemption activity and trading of leveraged exchange-traded funds that led to “chronic fails to deliver” in several ETFs for more than two years.
Wedbush served as the clearing firm for its broker-dealer customer, Scout Trading LLC, and acted as an authorized participant of various ETFs. According to FINRA, this enabled Wedbush to submit redemption/creation orders on Scout Trading’s behalf and on behalf of its other clients.
From January 2010 to March 2012, Scout Trading routinely submitted “naked” redemption orders in ETFs to Wedbush, meaning Scout Trading was “insufficiently long in the ETF shares comprising the redemption orders,” FINRA states.
“During the review period, Scout Trading submitted at least 255 naked redemption orders through Wedbush in 11 ETFs, totaling over 295 million shares,” FINRA states. “This naked redemption activity, along with short selling of the ETFs on the secondary market by Scout Trading, resulted in substantial, repeated fails to deliver by Wedbush.”
Scout Trading submitted creation orders, used to create new shares of the ETFs, through Wedbush to close out the fails to deliver; however, Scout Trading, shortly thereafter, submitted further naked redemption orders, or engaged in additional secondary market selling activity in the ETFs, through or with the assistance of Wedbush, that led to fails to deliver redeveloping at Wedbush.
This pattern of naked redemption orders followed by creation orders resulted in persistent and sustained fails to deliver at Wedbush, and was profitable but impermissible.